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FEDERAL  INCOME  TAX 

INCLUDING  TAX   ON  UNDISTRIOUTEli  NET 

INCOME,  CAPITAL  STOCK  TAX.  AND 

WAR  EXCESS  PRUEITS  TAX 


'BY 


CO.  *-•  ^ 


GEORGE  E.  HOLMES 

of  the  New  Yorli  Bar 


CHICAGO 

CALLAGHAN  AND  COMPANY 
1917 


Copyright  1917 

By 

GEORGE  E.  HOLMES 


^ 


PREFACE 


It  is  fortunate  that  we  passed  an  Income  Tax  law  in 
1913.  It  would  be  better  for  us  now  if  we  had  done 
so  ten  years  earlier.  "Without  an  Income  Tax  we  could 
not  raise  the  tremendous  sums  of  revenue  now  required ; 
and  with  a  new  law,  the  Internal  Revenue  employees 
would  be  like  an  array  of  raw  recruits.  They  have  had 
a  period  of  training  under  \he  1913  and  1916  Income 
Tax  Laws  which  is  now  of  inestimable  value. 

Our  system  of  Income  Tax  Laws  is  still  defective. 
Years  of  slow  development  are  needed  to  make  it  work 
smoothly  and  effectively.  This  can  take  place  only  hy 
the  discovery  and  application  of  correct  principles  to  the 
multitude  of  single  cases  which  will  arise  for  settlement 
either  by  the  Treasury  Department  or  by  the  Courts. 
This  book  attempts  to  show  what  the  law  is  in  its  present 
state  of  development  and  to  present  the  matter  in  a  form 
readily  accessible  to  the  reader.  It  is  not  a  discussion 
of  the  principles  of  taxation  but  a  practical  handbook 
for  present  use,  and  it  is  the  author's  hope  that  it  may 
be  found  of  some  value  for  that  purpose.  Criticisms 
of  its  shortcomings  and  suggestions  for  its  improvement 
will  be  thankfully  received. 

Much  criticism  has  been  directed  against  the  Treasury 
Department  for  its  narrow  construction  of  many  provi- 
sions of  the  law.  No  doubt  its  rulings  work  hardship 
on  occasion,  but  no  other  course  can  be  adopted.     The 

iii 

734021 


IV  PREFACE 

Treasury  Department  is  not  a  judicial  body — the  pnr- 
pose  of  its  existence  is  to  collect  revenue.  The  first 
rulings  and  the  general  rulings  must  construe  the  law 
narrowly,  leaving  the  taxpayer  to  protest  if  they  operate 
unfairly  in  his  ease.  If  a  broad  construction  were  in- 
dulged in  generally,  no  taxpayer  would  ever  call  atten- 
tion to  the  cases  where  it  resulted  in  allowing  revenue 
to  escape.  The  door  must  first  be  tightly  closed  and 
then  opened  in  particular  instances  where  necessary  and 
proper.  It  is  the  right  and  the  duty  of  every  taxpayer 
to  protest  when  he  feels  the  administration  of  the  law 
operates  unfairly  as  to  him.  The  law  makes  special 
provision  for  him  to  do  so. 

Unfortunately  there  are*  citizens  who  do  not  scruple 
to  evade  taxes  by  every  means  at  their  disposal.  The 
rulings  must  be  made  with  that  fact  in  view,  that  is, 
they  must  be  such  as  will  make  it  difficult  for  the  ' '  tax- 
dodger"  to  hide  behind  any  statement  of  the  officers 
charged  with  the  administration  of  the  law.  The  con- 
scientious taxpayer  is  sometimes  penalized  because  of 
this,  but  unless  he  sleeps  on  his  rights,  he  has  his  remedy 
at  hand. 

The  personnel  of  the  Treasury  Department  is  actuated 
by  a  high  sense  of  public  duty.  The  author  has  had  the 
pleasure  of  association  with  many  officials,  collectors  and 
inspectors  in  the  past  and  has  found  them  intelligent, 
fair-minded  and  just  in  their  dealings  with  the  taxpayer. 
Differences  of  opinion  as  to  taxable  income  or  allowable 
deductions  must  necessarily  arise,  and  when  they  do,  the 
officials  of  the  Treasury  Department  stand  always  ready 
to  give  the  taxpayer  full  opportunity  to  express  his  view 
and  to  raise  his  argument.  If  they  do  not  agree  with 
him,  it  is  because  they  are  bound  by  what  they  under- 
stand the  law  to  mean,  even  though  they  recognize  the 


PREFACE  V 

justice  of  his  contentions.  The  ultimate  remedy  in 
many  cases  is  to  improve  the  statute,  a  matter  to  which 
the  average  taxpayer  pays  no  attention. 

It  is  the  hope  of  the  author  that  this  book  may  point 
out  some  of  the  needs  for  amendment  of  the  statute  as 
well  as  to  give  the  taxpayer  a  clearer  idea  of  the  system 
by  which  the  taxes  are  assessed,  collected,  abated  and 
refunded.  The  author's  thanks  are  extended  to  the  many 
friends  who  have  given  him  helpful  suggestions  and 
criticisms  in  preparing  the  work,  and  particularly  to 
Mr.  A.  E.  Young  of  the  Pittsburgh  Bar  and  to  Messrs. 
Ross  W.  Lynn  and  T.  A.  Clements  of  the  New  York  Bar 
for  their  careful  reading  of  the  manuscript. 

George  B.  Holmes. 

New  York,  December  15,  1917. 


TABLE  OF  CONTENTS 


CHAPTER  PAGE 

1  Introduction  1 

2  The  Individual  Tax  Rates 15 

3  Individuals  to  Whom  the  Law  is  Applicable.  ...   20 

4  Citizens  and  Residents  of  the  United  States. ...  29 

5  Non-R«sident  Aliens 41 

6  Resident  Agents  for  Non-Resident  Aliens,  For- 

eign Corporations  and  Foreign  Partnerships . .   59 

7  Nominal  Stockholders 66 

8  P^'iduciaries 73 

9  Foreign   Fiduciaries 98 

10  Partnerships 103 

11  Foreign  Partnerships 117 

12  Corporations 125 

13  Special  Provisions  Applying  to  Insurance  Com- 

panies   166 

14  Foreign  Corporations  176 

15  Exempt  Corporations •. 193 

16  Income — In  General 205 

17  Income  from  Personal  Services 229 

18  Income  from  Business,  Trade  or  Commerce 236 

19  Income  from  Farming 242 

20  Income  from  Sales  or  Dealings  in  Property 245 

21  Income  from  Rent 252 

22  Income  from  Interest 255 

23  Income  from  Dividends 262 

vii 


Vlll  TABLE   OF    CONTENTS 

CHAPTER  ,  PAGE 

24  Income  from  Royalties 278 

25  Income  from  Miscellaneous  Sources 280 

26  Receipts  Which  Are  in  Part  Return  of  Capital . .  286 

27  Deductions — In  General " 296 

28  Deduction  of  Business  Expenses 304 

29  Deduction  of  Interest 320 

30  Deduction  of  Taxes 324 

31  Deduction  of  Losses 331 

32  Deduction  of  Allowance  for  Depreciation 346 

33  Deduction  of  Allowance  for  Depletion  of  Oil  and 

Gas  Deposits 360 

34  Deduction  of  Allowance  for  Depletion  of  Mines.  .373 

35  Return  of  Annual  Net  Income 382 

36  Assessment  and  Payment  of  the  Tax 398 

37  Penalties  and  Compromises 421 

38  Examination  of  Taxpayers  Books. 431 

39  Abatement,  Refund  and  Recovery  of  Taxes 435 

40  Information  at  the  Source 450 

41  Collection  of  the  Tax  at  the  Source 457 

42  Tax  Exempt  Covenants 482 

43  Constitutionality  of  the  Law 488 

44  Tax  on  Undistributed  Net  Income  of  Corpora- 

tions   495 

45  The  War  Excess  Profits  Tax .503 

46  The  Capital  Stock  Tax .534 


FEDERAL  INCOME  TAX 


CHAPTER  I 

INTRODUCTION  ^ 

At  present  the  Federal  Income  Tax  is  imposed  under 
two  statutes  prescribing  separate  and  different  rates, 
one  additional  to  the  other.  The  Act  of  Sept.  8,  1916 
(referred  to  in  this  book  as  the  1916  Law)  imposes  a 
tax  at  comparatively  low  rates  and  with  comparatively, 
high  exemptions.  This  Act  was  amended  in  many 
respects  by  the  Act  of  October  3,  1917,  but  remains  as 
a  separate  law  imposing  a  general  income  tax  in  con- 
tradistinction to  the  "war  income  tax"  which  was  also 
included  in  the  Act  of  October  3,  1917  (and  which  is 
referred  to  in  this  book  as  the  1917  Law.)  The  1917  Law 
contains  no  administrative  provisions,  but  it  provides 
that  the  tax  it  imposes  shall  be  computed,  levied, 
assessed,  collected  and  paid  upon  the  same  basis  and  in 
the  same  manner  as  the  similar  taxes  imposed  by  the 
1916  Law.     Generally  speaking  both  laws  are  adminis- 

1  The  purpose  of  this  chapter  is  tc  describe  briefly  the  salient 
provisions  and  requirements  of  the  law  and  the  system  of  admin- 
istration, so  that  the  reader  may  obtain  a  general  understanding 
of  the  subject  before  the  various  provisions  are  taken  up  and 
discussed   in   detail. 

1 
F.  T.  Tax.— 1 


Z  FEDERAL.  INCOME  TAX 

tered  as  one,  and  only  one  return  of  annual  net  income 
is  required  from  each  taxpayer,  on  the  basis  of  which 
both  taxes  are  assessed.** 

Preceding  Federal  Laws.  The  1916  Law  was  pre- 
ceded by  the  Act  of  October  3,  1913,  (referred  to  in 
this  book  as  the  1913  Law.)  This  law  remained  in  force 
without  change  or  amendment  up  to  September  9,  1916, 
when  the  1916  Law  went  into  effect.  The  1916  Law- 
contained  several  important  amendments  and  effected  an 
increase  in  rates  of  the  normal  and  supertaxes,  but  the 
general  provisions  of  both  laws  remained  very  much  the 
same,  and  rulings  and  decisions  under  the  1913  Law  are 
freely  referred  to  in  this  book  as  they  have  direct  appli- 
cation to  the  provisions  of  the  laws  now  in  force.  While 
the  1913  Law  was  the  first  general  income  tax  law  en- 
.  acted  after  the  adoption  of  the  Constitutional  Amend- 
ment permitting  the  imposition  of  an  income  tax  without 
apportionment  and  without  regard  to  any  census  or 
enumeration,  there  was  in  effect  in  this  country  from 
August  5,  1909,  to  January  1,  1913,  a  corporation  excise 
tax  act  (referred  to  in  this  book  as  the  1909  Law)  which 
imposed  a  special  excise  tax  on  corporations  with  respect 
to  the  carrying  on  or  doing  business  by  such  corporations. 
Though  the  1909  Law  was  not  intended  to  be  and  was  not 
in  any  proper  sense  an  income  tax  law  *  the  tax  was 

2  The  purpose  of  Congress  in  enacting  a  separate  ' '  war  income 
tax"  law  instead  of  increasing  the  rates  of  the  1916  Law,  was 
no  doubt  to  facilitate  a  return  to  the  lower  rates  when  the  present 
extraordinary  demand  for  revenue  has  ceased.  Thus,  the  present 
high  rates  and  low  exemptions  are  superimposed  temporarily  upon 
our  general  low  rates  and  high  exemptions,  a  return  to  which  is 
made  all  the  more  easy  by  leaving  the  1916  Law  intact. 

3  Justice  Pitney  in  Stratton  's  Independence  Limited  v.  How- 
bert,  231  U.  8.  399,  34  Sup.  Ct.  136,  58  L.  Ed.  285. 


INTRODUCTION  O 

measured  by  the  net  income  of  corporations  and  the 
language  of  the  subsequent  income  tax  laws  is  in  many 
instances  either  verbatim  or  very  similar.  To  that  extent 
decisions  and  rulings  under  the  1909  Law  throw  light 
on  the  construction  of  the  present  laws  and  for  that 
purpose  are  referred  to  in  this  book. 

Administration  of  the  Laws.  The  duty  of  administer- 
ing the  income  tax  laws  and  collecting  the  taxes  there- 
under is  imposed  on  the  Bureau  of  Internal  Revenue, 
which  is  a  part  of  the  Federal  Treasury  Department. 
The  bureau  is  in  the  charge  of  the  Commissioner  of 
Internal  Revenue,  who,  under  the  direction  of  the  Secre- 
tary of  the  Treasury,  has  general  superintendence  of  the 
assessment  and  collection  of  all  duties  and  taxes  imposed 
by  any  law  providing  internal  revenue:*  The  states  and 
territories  are  divided  into  some  sixty-four  collection 
districts,*  each  under  the  charge  of  a  collector  of  internal 
revenue,  with  one  or  more  deputy  collectors.  Returns 
of  net  income  are  filed  with  the  local  collector  and  the 
tax  is  paid  to  him,  although  the  assessments  are  made 
by  the  Commissioner  of  Internal  Revenue  at  Washington. 
Collectors  have  supervisory  power  over,  and  authority 
to  investigate,  all  accounts,  lists  or  returns  required  to 

4U.  S.  Rev.  Stats.,  §321. 

8  As  a  rule  the  boundaries  of  collection  districts  coincide  with 
the  boundaries  of  the  states,  but  sometimes  one  collection  district 
embraces  two  or  three  states,  or  one  state  is  divided  into  two  or 
more  collection  districts.  Districts  within  a  state  are  designated 
by  number,  as  the  first  and  sixth  districts  of  California,  being 
the  two  districts  of  that  state.  The  lack  of  sequence  in  number- 
ing is  due  to  the  consolidation  of  districts  from  time  to  time  since 
the  period  immediately  following  the  Civil  War,  when  the  country 
was  divided  into  the  maximum  number  of  districts. 


4  B^EDERAL    INCOME   TAX 

be  made  by  persons  liable  to  tax,^  may  send  agents  to  ex- 
amine the  books  of  such  taxpayers,  and  on  refusal  to  allow 
an  examination,  may  summon  such  person  or  corporation 
to  produce  the  books  and  to  appear  before  them  to  give 
testimony  or  answer  interrogatories  under  oath  respect- 
ing the  matter."  Collectors  may  make  returns  for  tax- 
payers from  their  own  knowledge  and  from  such  informa- 
tion as  they  can  obtain  through  testimony  or  otherwise 
in  cases  where  the  taxpayer  fails  to  file  a  return  or 
makes  a  false  or  fraudulent  return.*  Appeals  may  be 
taken  from  decisions  of  Collectors  to  the  Commissioner 
Internal  Revenue.® 

Revenue  Agents  and  Inspectors.  The  duties  of 
officers  of  this  class  are  to  ascertain  and  report  the 
names  of  persons  who  in  their  opinion  are  liable  to  the 
income  tax  and  who  have  failed  to  make  return  as 
required  by  law ;  to  inquire  into  income  tax  returns  where 
there  is  any  suspicion  that  the  return  made  is  erroneous ; 
to  examine  the  books  and  accounts  of  persons  who  have 
made  returns,  for  the  purpose  of  ascertaining  and  report- 
ing as  to  whether  the  law  has  been  complied  with,  when 
so  ordered  by  the  agent  in  charge  of  the  division  to 
which  they  are  assigned.  Reports  of  these  officers  are 
^made  to  the  agent  in  charge  of  the  division  to  which 
they  are  assigned  who  in  turn  reports  to  the  Commis- 
sioner of  Internal  Revenue  and  the  collector  of  the 
proper  district.  In  the  discharge  of  their  official  duties 
officers  of  this  class  are  expected  to  exercise  sound  dis- 
cretion, treat  all  persons  with  due  courtesy,  and,  while 

6U.  S.  V.  Hodson,  14  Int.  Rev.  Rec.  100. 

7  U.  S.  Rev.  Stats.,  §  3173. 

8  U.  S.  Rev.  Stats.,  §  3176. 

9  See  Chap.  39,  infra. 


INTRODUCTION  U 

acting  firmly  and  courageously,  to  avoid  all  contention 
or  controversy  that  would  give  just  ground  for  com- 
plaint." 

Rulings  and  Regulations.  For  the  guidance  of  col- 
lectors and  taxpayei*s  the  Commissioner  of  Internal 
Revenue  issues  from  time  to  time  rulings  and  regula- 
tions on  questions  which  arise  in  the  course  of  admin- 
istering the  law.  They  are  published  under  the  caption 
of  "Treasurj'  Decisions"  and  are  numbered  serially  for 
purpose  of  reference.**  At  intervals  large  compilations 
of  rulings  and  regulations  are  published  by  the  Bureau 
of  Internal  Revenue  and  these  are  designated  as  "Regu- 
lations" and  given  a  serial  number."  In  addition  to  the 
rulings  and  regulations  the  Department  issues  so-called 
mimeograph  letters  to  collectors,  more  or  less  confidential 
in  their  character  and  not  intended  for  general*  publica- 
tion. Frequently  such  letters  throw  light  on  the  admin- 
istration of  the  law  and  such  mimeograph  letters  as  have 
been  niade  public  are  referred  to  in  this  book. 

Retroactive  EppeCt  op  Rilings,  Generally  speaking 
any  ruling  or  regulation  made  by  the  Treasury  Depart- 
ment supersedes  all  prior  rulings  and  regulations  and  is 
retroactive  to  the  time  the  law  was  enacted,  since  a  ruling 
or  regulation  is  merely  an  interpretation  of  the  mean- 
ing of  the  law,  and  in  theory  the  meaning  has  been  the 

10  T.  D.  1932. 

11  Treasury  decisions  contain  rulings  on  all  aubjects  over  which 
the  Bureau  of  Internal  Revenue  has  jurisdiction.  Those  relating 
to  the  income  tax  are  therefore  not  numbered  in  sequence.  Ref- 
erence to  treasury  decisions  is  usually  made  by  employing  the 
abbreviation,  thus,  "T.  D.  2476." 

18  The  last  general  compilation  of  rulings  on  the  income  tax  i« 
known  as  "Regulations  No.  3.3"  issued  January  5.  1914. 


6  FEDERAL  INCOME   TAX 

same  from  the  beginning.  The  Treasury  Department 
recognizes,  however,  that  in  some  instances  it  woiild  be 
unjust  or  impracticable  to  reopen  returns,  adjustments 
or  assessments  which  have  been  made  in  accordance  with 
previous  rulings  and,  where  such  rulings  are  superseded, 
an  express  limitation  is  made  in  the  superseding  ruling 
or  regulation  as  to  the  retroactive  effect  thereof.^* 

Construction  of  the  Law.  A  statute  may  be  con- 
strued contrary  to  its  literal  meaning  when  a  literal 
construction  would  result  in  an  absurdity  or  inconsis- 
tency, and  the  words  are  susceptible  of  another  construc- 
tion which  carries  out  the  manifest  intention,  but  it  is 
a  well  settled  rule  of  interpretation  that  a  legislative  act 
is  to  be  interpreted  according  to  the  intention  of  the 
legislature  apparent  upon  its  face,^*  and  consequently 
the  statements  made  in  debate  at  the  time  of  the  passage 
of  the  law  have  no  particular  value  in  construing  the  act. 
Revenue  laws  are  not,  like  penal  laws,  to  be  construed 
strictly  in  favor  of  the  defendants.  They  are  rather  to 
be  regarded  as  remedial  in  their  character  and  so  con- 
strued as  to  carry  out  the  intention  of  the  legislature  in 
passing  them.^*  As  a  general  rule,  the  construction  by 
the  Treasury  Department  is  such  as  is  most  favorable 
to  the  enforcement  of  the  laws  and  no  liberal  interpreta- 
tion in  favor  of  the  individual  is  indulged  in.^®  The 
courts  construe  such  statutes  with  reasonable  fairness  to 

13  See  last  paragraph  of  mimeograph  letter  to  collectors  dated 
August  14,  1914;  ITS  1917,  f  264;  also  the  last  paragraph  of 
T.  D.  2m.3  and  T.  D.  2317. 

14  Wilkinson  v.  Deland,  2  Pet.  627;  U.  S.  v.  Union  Pacific  E.  E. 
Co.,  91  U.  S.  72. 

16  U.  S.  V.  Stowell,  13.3  U.  S.  1. 
16  18  Op.  Atty.  Gen.  246. 


INTRODUCTION  7 

the  citizen,*''  an  unjust  or  absurd  construction  is 
avoided  *•  and  laws  of  doubtful  or  double  meaning  are 
not  too  harshly  construed.  Courts  are  not  at  liberty,  by 
construction  or  legal  fiction  to  include  subjects  of  taxa- 
tion not  within  the  terms  of  the  law,  and  duties  are 
never  imposed  on  citizens  upon  vague  or  doubtful  inter- 
pretation.** Courts  do  not  extend  the  provisions  of 
taxing  statutes,  by  implication,  beyond  the  clear  import 
of  the  language  used,  or  enlarge  their  operations  to  em- 
brace matters  not  specifically  pointed  out.  In  case  of 
doubt  the  statute  is  construed  most  strongly  against  the 
Government,  and  in  favor  of  the  citizen.*®*  Where  the 
language  is  dubious  and  open  to  different  interpreta- 
tions the  construction  put  upon  it  by  the  Treasury  De- 
partment has  a  great,  and  generally  a  controlling,  force 
with  the  court,  but  in  order  to  be  binding  such  construc- 
tion of-  the  Department  must  be  long  continued  and 
unbroken,  and  the  rule  has  no  application  where  the 
statute  is  ambiguous,  or  where  it  will  not  bear  the  inter- 
pretation put  upon  it  by  the  administrative  officers.''^ 

Porto  Rico  and  the  Philippines.  In  Porto  Rico  and 
the  Philippine  Islands  the  law  is  administered  and  the 

17  U.  S.  V.  DistUled  Spirits,  10  Blatch.  428. 

Win  re.  Chapman,  166  U.  S.  661. 

l»Hartranft  v.  Weigmann,  121  U.  S.  609,  Mutual  Benefit  Insur- 
ance Company  v,  Herold,  198  Fed.  199. 

19*  United  States  v.  Wigglesworth,  2  Story  369;  American  Net 
and  Twine  Co.  v.  Worthington,  141  U.  S.  468;  Benziger  v.  United 
States,  192  U.  S.  38;  Gould  v.  Gould,  No.  41,  Oct.  Term,  1917, 
U.  S.  Supreme  Court — not  yet  officially  reported. 

80  St.  Paul,  etc.,  Railway  Co.  v.  Phelps,  137  U.  S.  528;  Merritt 
V.  Cameron,  137  U.  8.  542;  U.  8.  v.  Hill,  120  U.  8.  169;  Swift 
Company  v.  U.  8.,  105  U.  S.  691;  U.  8.  v.  Graham,  110  U.  8. 
219;  U.  8.  V.  Tanner,  147  U.  8.  661;  U.  8.  v.  Alger,  152  U.  S. 
384. 


e  FEDERAL   INCOME   TAX 

tax  is  collected  by  the  appropriate  internal  revenue 
officens  of  those  governments,  and  the  tax  so  collected 
accrues  intact  to  the  general  governments  thereof  respec- 
tively.^^ This  does  not  mean,  however,  that  a  separate 
tax  is  imposed  on  income  arising  in  those  jurisdictions. 
If  a  taxpayer  is  required  under  the  law  to  make  his 
return  in  a  collection  district  located  in  any  state  or 
territory,  he  pays  his  tax  there  on  income  from  all 
sources,  including  Porto  Rico  and  the  Philippines,  and 
pays  no  tax  in  any  other  district  or  jurisdiction.'^^  The 
1917  Law  does  not  extend  to  Porto  Rico  and  the  Philip- 
pines, and  the  legislatures  thereof  are  given  power,  under 
the  1917  Law,  as  amended,  to  alter,  amend  or  repeal 
the  income  tax  laws  within  their  respective  jurisdic- 
tions.2' 

Virgin  Islands.  The  income  tax  laws  h^ve  not 
expressly  l)een  made  applicable  to  the  islands  recently 
acquired  from  Denmark.  The  words  "United  States" 
are  defined  in.  the  1916  Law  to  include  any  Territory, 
the  District  of  Columbia,  Porto  Rico,  and  the  Philippine 
Islands.*^*  Hence,  the  status  of  residents  of  our  new 
possessions  is  uncertain  under  the  present  statutes,  as 
is  also  the  status  of  residents  in  other  possessions  not 
enumerated  in  the  above  definition.^^ 

21  Act  of  September   8,   1916,   §  23. 

22  Letter  from  Treasury  Department  dated  April  4,  1917. 

23  Act  of  October  3,  1917,  Title  I,  §  5.  Since  this  power  exists 
it  is  no  longer  safe  to  assume  that  the  laws  in  those  possessions 
are  identical   with   the   federal   law. 

24  Id.,  §15. 

26  It  seems  the  inhabitants  of  those  possessions  are  "non-resi- 
dent aliens"  within  the  meaning  of  the  term  as  used  in  the  1916 
Law.     See  Sec.  1  (a)  and  Sec.  1.5. 


INTRODUCTION  9 

Reporting  Net  Income.  Taxpayers  are  required  to 
file  annually  a  report  (referred  to  in  the  law  and  the 
regulations  as  a  return  of  net  income)  showing  the 
amount  of  taxable  income  received,  the  deductions  and 
exemptions  claimed,  and  the  net  income  upon  which  the 
tax  is  to  be  imposed.  This  return  is  filed  in  the  collec- 
tion district  in  which  the  taxpayer  resides  or  has  his 
principal'  place  of  business.  Non-residents  having  no 
place  of  business  in  this  country  file  their  returns  with 
the  collector  of  internal  revenue  at  Baltimore,  Mary- 
land.^ The  tax  is  paid  in  the  district  in  which  the 
return  is  filed.  The  return  of  annual  net  income  is 
filed  by  individuals  on  or  before  March  1  in  each  year. 
In  it  is  reported  the  income  received  during  the  preced- 
ing calendar  year.  Corporations  also  file  an  annual  re- 
turn at  the  same  time,  and  for  the  same  period,  except 
those  corporations  which  have  elected  to  report  for  their 
fiscal  yeai-s  instead  of  the  calendar  year,  in  which  case 
the  return  is  filed  within  sLxty  days  after  the  close  of  the 
fiscal  year.^'''  Partnerships,  as  such,  file  no  annual  re- 
turns.*' 

Individuals.  No  person  whose  net  income  is  less 
than  $1,000  in  any  calendar  year  is  required  to  file  a 
return  for  that  year.  Unmarried  persons  receiving 
!^1,000  or  more  net  income  during  the  calendar  year,  and 
married  persons  receiving  $2,000  or  more  net  income 
during  the  same  period,  are  re<iuired  to  file  the  annual 

86  This  district  is  the  one  in  which  Washinjfton,  tho  national 
<-.'i|iit;il,  is  located.  . 

27  See  Chapter  12, 

28  See  Chapter  10. 


10  FEDERAL  INCOME  TAX 

return,  although  after  deducting  the  personal  exemptions 
to  which  they  are  entitled  no  tax  may  be  due.*^ 

Personal  Exemption.  The  personal  exemption  is  an 
arbitrary  amount  of  net  income  on  which  residents  and 
citizens  are  not  taxed.  It  may  be  said  to  be  an  amount 
allowed  for  personal  or  family  expenses,  the  actual 
amount  of  such  expenses  not  being  deductible  from  gross 
income  in  the  annual  return.  Non-resident  aliens  are  not 
entitled  to  claim  any  personal  exemption,  but  are  taxed 
on  their  entire  net  income  from  sources  within  this 
country.  Corporations,  also,  are  not  allowed  any  exemp- 
tion, but  are  taxed  upon  their  entire  net  income  what- 
ever the  amount  may  be.  The  amount  of  personal  exemp- 
tion allowed  depends  upon  the  status  of  the  individual. 
Under  the  1916  Law  single  persons  are  entitled  to  an 
exemption  of  $3,000,  married  persons  living  together, 
and  heads  of  families  whether  married  or  not,  are  entitled 
to  an  aggregate  exemption  of  $4,000.  Under  the  1917 
Law  the  personal  exemptions  are  $1,000  and  $2,000, 
respectively.  Under  each  law  an  additional  exemption 
of  $200  is  allowed  to  the  head  of  the  family  for  each' 
child  dependent  upon  him,  if  under  eighteen  years  of 
age,  or  of  any  age  if  the  child  is  incapable  of  self-support 
because  mentally  or  physically  defective.  The  personal 
exemption  may  be  deducted  only  in  computing  the 
normal  tax,  which  is  imposed  upon  the  entire  net  income 
of  the  individual  over  and  above  such  exemption.  Since 
the  income  tax  is  assessed  under  two  separate  laws  with 
different  rates  and  different  exemptions,  each  individual 
is  entitled  to  two  personal  exemptions  but  this  does  not 
mean  that  he  is  entitled  to  the  sum  of  the  two,  that  is 

«9See  Chapter  5  as  to  requirements  for  filing  returns  in  the 
case  of  non-resident  aliens. 


INTRODUCTION  11 

to  say,  while  a  single  person  is  entitled  to  a  personal 
exemption  of  $3,000  under  the  1916  Law  and  ^1,000 
under  the  1917  Law,  this  does  not  give  him  a  total 
exemption  of  $4,000.  Each  exemption  is  used  only  in 
computing  the  tax  due  under  the  law  to  which  it  applies 
and  has  no  application  to  the  other  law.^® 

Normal  Tax.  In  the  case  of  individuals  a  normal 
tax  of  2%  is  payable  on  the  entire  net  income  of  the 
individual,  over  and  above  the  exemptions,  under  each 
law,  making  in  the  case  of  single  persons  a  total  normal 
tax  of  4%  on  all  incomes  over  $3,000  and  a  normal  tax 
of  2%  of  the  amount  between  $1,000  and  $3,000.  In 
the  case  of  married  persons  and  heads  of  families  the 
total  normal  tax  is  4%  on  all  income  over  $4,000  and 
2%  on  the  income  between  $2,000  and  $4,000.  Non- 
resident alien  individuals  are  subject  only  to  the  2% 
normal  tax  imposed  by  the  1916  Law,  the  normal  tax 
imposed  by  the  1917  Law  being  expressly  limited  to 
citizens  and  residents  of  this  country. 

Supertax.  In  addition  to  the  normal  tax  payable 
under  each  law  a  supertax  is  imposed  under  the  1916 
Law  on  all  incomes  over  $20,000.  The  supertax  is  grad- 
uated so  as  to  bear  more  heavily  as  the  amount  of  net  in- 
come increases.  Under  the  1917  Law  the  supertax  com- 
mences at  $5,000.  The  law  refers  to  the  supertax  as  the 
"additional  tax"  but  for  the  sake  of  clearness  the  tax  will 
be  referred  to  in  this  book  as  the  supertax.  The  supertax 
is  assessed  on  the  entire  net  income  of  each  individual, 
in  excess  of  the  minimum  amounts,  but  on  the  separate, 
not  combined,  incomes  of  husband  and  wife.  While  in 
the  case  of  non-resident  aliens  only  one  normal  tax  is 

80  For  a  farther  discussion  of  the  personal  exemption  see  the 
chapter  on  citizens  and  residents. 


12  FEDERAL   INCOME   TAX   ' 

assessed,  the  supertaxes  of  both  the  1916  Law  and  the 
1917  Law  are  applicable  to  them  with  respect  to  their 
entire  *net  income  received  from  sources  within  the 
United  States  in  excess  of  $20,000  and  $5,000,  respec- 
tively.^^ 

Corporation  Tax.  The  rate  of  tax  imposed  upon 
the  net  income  of  corporations  is  2%  under  the  1916 
Law  and  4%  under  the  1917  Law  making  a  total  of 
6%.  This  total  rate  applies  to  all  corporations,  whether 
domestic  or  foreign,  and  to  all  amounts  of  income  no 
matter  how  large  or  how  small,  except  that  for  the  pur- 
pose of  computing  the  amount  of  net  income  under  the 
1917  Law  dividends  received  by  one  corporation  on  the 
stock  of  another  corporation  may  be  deducted,  Ijut  in 
determining  the  net  income  for  the  1916  Law  such 
dividends  must  be  included.^* 

Collection  of  the  Tax  at  the  Source.  Collection  at 
the  source,  deduction  at  the  source,  withholding  at  the 
source  and  stoppage  at  the  source,  are  synonymous  terms 
meaning  that  the  one  paying  income  to  another  deducts 
or  withholds  an  amount  equal  to  the  tax  on  the  sum  so 
paid  and  turns  it  over  to  the  Government  to  the  credit 
of  the  one  against  M'hom  it  was  withheld.  This  method 
is  used  in  order  to  facilitate  the  collection  of  .the  tax 
and  to  prevent  evasion.  Collection  at  the  source  applies 
at  the  present  time  only  to  (a)  payments  of  fixed  and 
determinable  annual  or  periodical  income  to  non-resident 
alien  individuals,  (b)  payments  of  interest  on  bonds 
and  similar  obligations  of  domestic  corporations  to  non- 
31  See  Chapter  2  for  further  statement  of  the  rates  of  tax. 
32  For  a  further  discussion  of  this  subject  see  Chapter  12  on 
corporations. 


INTRODUCTION  13 

resident  foreign  partnerships  and  non-resident  foreign 
corporations,  (e)  payments  of  dividends  to  non-resident 
foreign  corporations  and  (d)  payments  of  interest  on 
bonds  and  similar  obligations  of  corporation«,  if 
such  l)onds  contain  a  so-called  "tax-free  covenant" 
which  requires  the  corporation  to  assume  the  burden  of 
the  tax  which  it  may  be  required  to  withhold  or  deduct 
from  the  interest  paid  to  its  bondholders.'^  In  the  last 
of  the  aforementioned  cases  deduction  applies  whether 
the  recipient  of  the  income  is  a  citizen  or  alien,  resident 
or  non-resident.  With  this  exception  no  withholding 
is  required  against  citizens  and  residents  of  this  country. 

Information  at  the  Source.  For  the  purpose  of 
checking  up  the  returns  of  taxpayers  the  law  provides 
for  a  system  of  information  at  the  source  whereby  every 
corporation  may  be  required  to  report  to  the  Commis- 
sioner of  Internal  Revenue  the  names  and  addresses  of 
its  stockholders  and  the  amount  of  dividends  paid  to 
each ;  stockbrokers  may  also  be  required,  when  called 
upon,  to  report  the  names  and  addresses  of  castomers 
and  information  as  to  the  profits  and  losses  of  each,  and 
all  persons,  corporations  or  partnerships  may  be  required 
to  report  the  names  and  addresses  of  any  persons  to 
whom  they  pay  fixed  or  determinable  gains,  profits  or 
income  of  $800  or  more  in  any  taxable  year.  In  the 
case  of  payments  of  interest  to  the  bondholders  of  cor- 
porations the  names  and  addresses  of  such  bondholders 
are  required  to  be  reported  regardless  of  the  amount 
paid  during  the  year  as  is  also  the  rule  in  the  case 
of  collection  of  foreign  items  of  interest  and  dividends.'* 

88  See  Chapter  41  on  Collection  at  the  Source. 
84  For  a  further  discussion  of  this  subject  see  the  chapter  on 
Information  at  the  Source. 


14  FEDERAL.  INCOME  TAX 

Tax  Due.  The  income  tax  is  due  and  payable  ordi- 
narily on  the  15th  day  of  June  following  the  filing  of 
the  return  of  annual  net  income,  but  may  be  paid  with- 
out penalty  within  ten  days  after  demand  for  payment 
has  been  made  by  the  local  collector.  Since  demand 
for  payment  cannot  be  made  before  the  due  date,  the 
tax  may  be  paid  without  penalty  within  ten  days  there- 
after, and  this  period  of  grace  is  extended  if  the  col- 
lector fails  to  make  a  prompt  demand.  In  the  case  of 
corporations  reporting  for  their  fiscal  year  the  tax  is 
due  and  payable  one  hundred  and  five  days  after  the 
date  on  which  the  return  is  required  to  be  filed,  that  is, 
within  one  hundred  and  sixty-five  days  after  the  close 
of  the  fiscal  year,  with  a  like  period  of  grace  of  ten  days 
after  demand  for  the  tax  has  been  made.  The  tax  may 
be  paid  in  advance  in  instalments  if  the  taxpayer  chooses 
to  do  so,  and  in  such  cases  the  Secretary  of  the  Treasury 
may  allow  a  discount  at  a  rate  not  exceeding  3%  per 
annum. 2* 

Abatement  and  Refund.  The  collection  of  the  in- 
come tax  cannot  be  restrained  by  injunction,  but  if  taxes 
have  been  erroneously  or  illegally  assessed  or  collected, 
the  Commissioner  of  Internal  Revenue  is  authorized  to 
remit  and  pay  back  the  amount  to  the  taxpayer.  The 
importance  of  collecting  revenue  is  so  great  that  the 
law  permits  no  taxpayer  to  interpose  a  hindrance  to 
the  orderly  assessment  of  the  tax.  He  must  allow  the 
assessment  to  be  made  and  may  thereafter  claim  abate- 
ment or  refund  by  filing  a  claim  with  the  local  collector .^^ 

86  For  a  further  discussion  of  this  subject  see  Chapter  36  on 
assessment  and  payment  of  the  tax. 

86  See  Chapter  39  for  procedure  as  to  abatement  and  refund. 


CHAPTER  2 

% 

THE  INDIVIDUAL   TAX   RATES 

As  indicated  in  the  foregoing  chapter  the  income  tax 
is  at  present  assessed  and  collected  under  two  laws.  The 
amount  of  tax  to  which  each  individual  is  liable  is  com- 
puted separately  under  each  law  and  the  two  amounts 
are  added  together  to  determine  his  total  liability.  Each 
law  prescribes  a  fixed  rate,  known  as  the  normal  tax,  and 
a  series  of  graduated  rates,  known  as  the  additional  tax, 
supertax  or  surtax.  In  the  case  of  corporations  no  super- 
tax is  imposed,  the  rate  being  uniform  on  all  amounts 
of  net  income. 

NormaJ  Tax.  Under  the  1916  Law  a  normal  tax  of 
2%  is  imposed  upon  the  entire  net  income  received 
during  the  taxable  year  from  all  sources  by  every  in- 
dividual a  citizen  or  resident  of  the  United  States,  and 
upon  the  entire  net  income  received  during  the  taxable 
year  from  all  sources  within  the  United  States  by  every 
individual,  a  non-resident  alien,  including  interest  on 
bonds,  notes  and  other  interest-bearing  obligations  of 
residents,  corporate  or  otherwise.  Under  the  1917  Law 
a  normal  tax  of  2%  is  imposed  upon  the  net  income  of 
every  individual,  a  citizen  or  resident  of  the  United 
States,  received  in  the  calendar  year  1917  and  every 
calendar  year  thereafter.  A  citizen  of  the  United  States, 
wherever  he  may  reside,  is  subject  to  both  normal  taxes. 

15 


16  FEDERAL   INCOME  TAX 

An  alien  is  subject  to  both  normal  taxes  if  he  resides  in 
this  country,  but  only  to  the  2%  normal  tax  under  the 
1916  Law  if  he  resides  outside  this  country.  In  assessing 
the  normal  tax  under  the  1916  Law,  the  personal  exemp- 
tion allowed  under  that  law  is  first  deducted  from  the 
net  income,  and  similarly  in  assessing  the  normal  tax 
under  the  1917  Law  the  personal  exemption  allowed  un- 
der that  law  is  first  deducted.  On  all  the  net  income  in 
excess  of  the  exemptions  the  normal  rate  applies. 

Supertax.  In  addition  to  the  normal  tax  a  supertax, 
called  in  the  law  "the  additional  tax"  is  imposed  at 
various  rates  under  the  1916  Law  and  the  1917  Law.  For 
the  purpose  of  assessing  the  supertax  the  personal  exemp- 
tions are  not  deducted.     The  rates  are  as  follows: 

On  the  amount  by  which  the  total  net  income 


But  does  not 

.1916 

1917 

Exceeds 

Exceed 

Law. 

Law. 

5,000* 

7,500 

None 

1% 

7,500 

10,000 

None 

2% 

10,000 

12,500 

None 

3% 

12,500 

15,000 

None 

4% 

15,000 

20,000 

None 

5% 

20,000 

40,000 

1% 

7% 

40,000 

60,000 

2% 

10% 

60,000 

80,000 

3% 

14% 

80,000 

100,000 

4% 

-       18% 

100,000 

150,000 

'5%- 

22% 

150,000 

200,000 

6% 

25% 

200,000 

250,000 

7% 

30% 

250,000 

:100,000 

8% 

M'Tv 

300,000 

500,000 

9% 

37% 

500,000 

750,000 

10% 

40% 

THE  INDIVIDUAL  TAX   RATES  17 

On  the  amount  by  which  the_  total  net  income 

But  does  not  1916  1917 

Exceeds  Exceed  Law.  Law. 

*        750,000  1,000,000  10%  45% 

1,000,000  1,500,000  11%  50% 

1,500,000  2,000,000  12%  50% 

Over  2,000,000  13%  50% 

Computing  the  Tax — Illustr^vtion.  The  tax  on  a 
married  person  with  a  net  income  of  $50,000  for  the  year 
is  computed  as  follows: 

Normal  Tax. 

$50,000   minus   $4,000    (per-      1916    Law.     1917    Law. 
sonal     exemption)     equals     , 
$46,000  at 2%      $920 

$50,000    minus  $2,000    (per- 
sonal    exemption)     equals 


J.v^,wrvr,         ^^ 

Supertax 

—  /tj 

Qn  first 

$  5,000 

0 

0 

On  next 

2,500 

0 

1% 

25 

(IS, 000  lo  $7,500) 

On  next 

2,500 

0 

2% 

50 

($7. .100  10  $10,000) 

On  next 

2,500 

0 

3% 

75 

($10,000  IO$13.500) 

On  next 

2,500 

0 

4% 

100 

r$IS.500  to  $15,000) 

On  next 

5,000 

0 

5% 

250 

($15,000  to  $20,000) 

On  next 

20,000 

1% 

200 

7% 

1,400 

($20,000  to  $40,000) 

On  next 

10,000 

2% 

200 

10% 

1,000 

($40,000  to  $50,000) 

$1,320 

• 

Totals 

$50,000 

$3,860 

1,320 

Total  income  taxe  due $5.1 80 

F.  I.  Tax. — 2 


18  FEDERAL,  INCOME  TAX       . 

The  tax  on  an  unmarried  person  would  be  increased 
by  2%  on  $2,000,  or  $40,  since  the  personal  exemption  is 
$1,000  less  under  each  law.  In  case  a  married  person 
or  the  head  of  a  family  is  entitled  to  further  exemption 
because  of  dependent  children,  the  normal  tax  will  be 
reduced  at  the  rate  of  $8  for  each  such  child,  that  is, 
2%  on  $200  under  each  law. 

Husband  and  Wife.  Where  a  husband  and  wife  make 
returns  of  their  joint  incomes  the  supertax  is  not  com- 
puted on  the  joint  income  of  both,  but  on  the  separat-e 
income  of  each,  although  the  incomes  of  both  may  be 
reported  on  the  same  return.^ 

Supertax  on  Stockholders  in  Respect  of  Undistributed 
Profits  of  Corporations.  The  supertax  is  ordinarily 
assessed  only  upon  the  income  actually  received  by  the 
taxpayer  but  where  an  individual  forms  or  fraudulently 
avails  himself  of  a  corporation  for  the  purpose  of  pre- 
venting the  imposition  of  the  supertax  through  the 
medium  of  permitting  the  gains  and  profits  of  such  cor- 
poration to  accumulate,  instead  of  being  divided  or 
distributed,  the  law  provides  that  for  the  purpose  of  the 
supertax  the  taxable  income  of  such  individual  shall 
include  the  share  to  which  he  would  be  entitled  of  the 
gains  and  profits  of  such  corporation  if  they  were^ 
divided  or  distributed.  This  provision  applies  only 
where  the  accumulation  is  permitted  for  the  purpose  of 
fraudulently  avoiding  the  supertax.  Ordinarily,  the 
stockholder  of  a  corporation  has  no  need  to  concern  him- 
self with  this  provision  or  to  make  any  inquiry  as  to 
the  undistributed  income  of  the  corporation.*    If  a  cor- 

IT.  D.  2090;  T.  D.  2137. 
2  T.  D.  2135. 


THE  INDIVIDUAL  TAX  BAT£S  19 

poration  is  a  mere  holding  company,  or  the  gains  and 
profits  are  permitted  to  accumulate  beyond  the  reason- 
able needs  of  the  business,  that  fact  is  prima  facie  evi- 
dence of  a  fraudulent  purpose  on  the  part  of  the  stock- 
holders to  escape  the  supertax.  Neither  the  collectors 
nor  the  Commissioner  of  Internal  Revenue,  however, 
have  any  authority  to  decide  when  the  surplus  or  un- 
divided profits  of  a  corporation  are  accumulated  beyond 
the  reasonable  needs  of  the  business,  and  therefore  tax- 
able under  this  provision  as  though  distributed.  The 
Secretary  of  the  Treasury  must  first  certify  that  in  his 
opinion  the  accumulation  is  unreasonable.  "When  he  has 
so  certified  the  stockholders  are  notified  thereof  and 
called  upon  to  add  the  amount  of  their  respective  shares 
in  the  undistributed  gains  and  profits  of  the  corporation 
for  the  year  to  their  income  from  other  sources  and  to 
pay  the  supertax  accordingly.' 

8  Act  of  September  8,  1916,  §  3. 


CHAPTER  3 

INDIVIDUALS  TO  WHOM  THE  LAW  IS  APPLICABLE 

I 

The  theory  upon  which  the  tax  is  imposed  seems  to  be 
two-fold.  The  law  imposes  the  tax  upon  the  entire  net 
income  of  all  persons  within  its  jurisdiction,  regardless 
of  where  the  income  arises,  and  on  all  income  arising  in 
the  United  States,  regardless  of  whether  or  not  the 
United  States  has  jurisdiction  of  the  person  who  receives 
it.  The  tax  has  been  defined  as  a  tax  on  the  person, 
measured  by  his  ability  to  pay,  that  is,  his  net  income,^ 
and  as  a  tax  on  the  income  itself.^  As  a  matter  of  fact,  it 
is  both.  The  Government  claims  personal  jurisdiction 
over  all  of  its  citizens  wherever  they  reside  and  over  all 
aliens  who  reside  within  its  borders.  Hence,  as  to  citi- 
zens and  resident  aliens,  the  tax  is  imposed  on  income 
from  all  sources  whether  arising  in  this  country  or  in  a 
foreign  country.  No  jurisdiction  can  be  claimed  over 
the  persons  of  non-resident  aliens,  but  so  far  as  their 
income  is  received  from  sources  in  this  country  it  is 
taxed  on  the  theory  that  the  Government  has  jurisdiction 

1  In  Brady  v.  Anvlerson,  240  Fed.  665,  the  court  said :  "In  our 
opinion  the  tax  is  against  citizens  and  residents  of  the  United 
States  personally.  They  are  chargeable  in  respect  to  income  re- 
ceived by  them." 

8  In  a  case  decided  by  the  Supreme  Judicial  Court  of  Massa- 
chusetts, Suter  V.  Jordan-Marsh  Company,  113  N.  E.  580,  it  was 
held  that  the  tax  was  levied  upon  the  rent  paid  by  the  defendant 
to  the  plaintiff. 

20 


INDIVIDUALS    TO    WMOM    LAW    IS    AI'l'LlCABLK  21 

over  the  income,  grauts  protection  to  tlie  creation  of 
such  income,  and  is,  therefore,  entitled  to  a  share  thereof 
to  defray  the  expenses  of  govenunenl.  The  fact  that  a 
person  is  taxable  in  foreign  countries  on  all  or  part  of 
his  income  does  not  relieve  him  for  that  reason  from  tax 
liability  on  the  same  income  in  this  country.* 

Persons  Exempt  from  the  Tax.  The  only  citizens  or 
residents  who  are  exempt  from  all  requirements  of  the 
law  are  those  receiving  less  than  $1,000  of  income  dur- 
ing the  year,  if  unmarried,  or  l^s  than  $2,000,  if  mar- 
ried. Non-resident  aliens  are  not  exempt  no  matter 
how  small  the  income,  provided  it  is  received  from 
sources  within  this  country.  Individuals  »iay,  however, 
enjoy  an  exemption  from  the  tax  because  of  the  character 
of  the  income  they  receive,  since  the  law  expressly  pro- 
vides that  certain  kinds  of  income  shall  not  be  subject 
to  the  tax.  Among  the  items  of  income  so  exempt  are 
the  proceeds  of  life  insurance  policies  paid  to  individual 
beneficiaries  upon  the  death  of  the  insured ;  the  amount 
received  by  the  insured  as  a  return  of  premiums  ^aid 
by  him  under  life  insurance,  endowment,  or  annuity 
contracts,  property  acquired  by  gift,  bequest,  devise,  or 
descent  (but  the  income  from  such  property  is  taxable), 
interest  on  the  o))ligations  of  a  State  or  any  political 
subdivision  thereof  or  upon  the  obligations  of  the  United 
States  (to  the  extent  provided  in  the  Act  authorizing  the 
i.ssue,  if  the  bonds  are  issued  after  September  1,  1917), 
or  its  possessions  or  securities  issued  under  the  pro- 
visions of  the  Federal  Farm  Loan  Act  of  July  17,  1916: 
and  the  compensation  of  all  oflficers  and  employees  of  a 
state,  or  any  political  subdivision  thereof,  except  when 
such  compensation  is  paid  by  the  United  States  Govem- 

8T.  D.  2152. 


22  FEDERAL  INCOME  TAX 

ment.  Under  these  provisions  officers  and  employees  of 
a  state,  city  or  county,  including  public  school  teachers, 
etc.,  are  exempt  from  the  tax  to  the  extent  that  their 
income  is  derived  fr^  salaries  paid  by  the  state,  county 
or  city.  They  enjoy,  however,  no  exemption  from  tax 
on  income  from  taxable  sources  merely  because  of  their 
position  as  employees  of  a  state.  The  Act  also  exempts 
from  tax  the  compensation  of  the  present  President  of 
the  United  States  during  the  term  for  which  he  has  been 
elected  and  the  judges  of  the  Supreme  Court  and  infer- 
ior courts  of  the  United  States  in  office  at  the  time  the 
Act  was  passed.  Exempt  income  is  omitted  from  the 
returns  of  annual  net  income  of  individuals  but  is  re- 
quired to  be  reported  by  corporations. 

Citizens  of  the  United  States.  For  the  purpose  of 
the  income  tax  law  no  distinction  is  made  between 
native  and  naturalized  citizens.  They  are  taxable  upon 
their  entire  net  income  from  all  sources  whether  they 
reside  within  this  country  or  not.  Married  women  are 
considered  to  have  the  same  citizenship  as  their  hus- 
bands. An  American  woman  who  marries  a  foreigner 
consequently  loses  her  status  as  an  American  citizen 
and  is  thereafter  treated  as  an  alien.*  But  determina- 
tion by  the  State  Department  of  the  status  of  an  individ- 
ual is  not  conclusive  upon  the  Treasury  Department  in 
fixing  citizenship  for  income  tax  purposes.* 

Residing  in  the  United  States.  Citizens  residing 
in  the  United  States  report  and  pay  the  tax  in  the  dis- 
trict in  which  they  reside  or  have  their  principal  place 
of  business,  regardless  of  where  the  income  may  arise. 

4T.  D.  2092. 
BT.  D.  2135. 


INDIVIDUALS    TO    WHOM    LAW    IS    APPLICABLE  23 

Residing  Abroad.  If  a  citizen  residing  abroad  has 
no  office  or  place  of  business  in  this  country  he  files  his 
return  and  pays  his  tax  to  the  Collector  of  Internal 
Revenue  at  Baltimore,  Maryland.  He  is,  of  course,  re- 
quired to  report  his  income  from  all  sources  whether 
within  or  without  the  United  States.  Although  the  ques- 
tion as  to  the  liability  of  a  non-resident  citizen  is  not 
determined  by  the  State  Department  but  by  the  Treasury 
Department,  still,  in  the  case  of  a  naturalized  citizen 
against  whom  the  presumption  of  expatriation  has 
arisen,  the  fact  that  he  has  paid  the  income  tax  will  re- 
ceive due  consideration  by  the  State  Department  in  con- 
nection with  other  evidence  submitted  to  overcome  such 
presumption  in  connection  with  applications  for  pass- 
ports or  for  registration  in  a  consulate  or  for  actual 
protection  in  a  foreign  country.  The  payment  of  the 
income  tax  will  also  be  duly  considered  by  the  State 
Department  in  passing  upon  rights  to  the  continued 
protection  of  this  Government  in  cases  of  native  Ameri- 
can citizens  who  have  resided  abroad  for  a  period 
so  long  that  the  natural  presumption  may  be  held  to 
have  arisen  that  they  have  abandoned  citizenship  in  this 
country.® 

Aliens  Residinsf  in  the  United  States.  The  question 
of  whether  or  not  an  alien  resides  in  this  country  is 
sometimes  difficult  to  determine.  The  Treasury  Depart- 
ment has  held  that  where  for  business  purposes  or 
otherwise  an  alien  is  permanently  located  in  the  United 
States,  has  there  his  principal  business  establishment 
and  is  there  permanently  occupied  or  employed,  even 
though  his  domicile  may  be  without  the  United  States, 

•  Letter  from  Secretary  of  State  to  American  Diplomatic  and 
Consular  0£Scer8,  dated  March  18,  1914. 


24  FEDERAL  INCOME  TAX 

he  will  be  held  to  be  residing  in  the  United  States.  On 
the  other  hand  an  alien  physically  present  in  the  United 
States,  but  only  temporarily  residing  or  employed  here 
(as  for  a  season  or  other  similiar  definite  term)  and  with 
the  expectation  of  leaving  the  United  States  upon  the 
termination  of  employment  or  accomplishment  of  the 
purpose  which  necessitates  his  presence  in  the  United 
States,  will  be  considered  a  non-resident.'''  The  Treasury 
Department  has  adopted  the  following  definition  of  the 
word  "residence"  as  used  in  the  income  tax  laws: 
"That  place  where  a  man  has  his  true,  fixed  and  perma- 
nent home  and  principal  establishment,  and  to  which, 
whenever  he  is  absent,  he  has  the  intention  of  returning ; 
and  indicates  permanency  of  occupation  as  distinct  from 
lodging  or  boarding,  or  temporary  occupation. ' '  ^ 
Aliens  coming  into  the  United  States  .with  the  intention 
of  becoming  residents  may  establish  that  fact  and  have 
the  privilege  of  resident  aliens  under  the  statute,  by 
filing  a  certificate  ^  with  the  withholding  agents  charged 
with  the  duty  of  withholding  the  tax  on  income  paid  to 
non-resident  aliens. 

Non-Resident  Aliens.  Non-resident  aliens  are  those 
persons  who  are  neither  citizens  nor  residents  of  this 
country.  As  stated  above,  they  are  taxable  only  to 
the    extent    of   the   income    they   derive    from   sources 

7  This  rule  differs  from  the  English  rule  which  provides  that 
a  person  within  the  United  Kingdom  for  some  temporary  purpose 
only  for  less  than  six  months  during  the  year  is  not  taxable  as  a 
resident  but  after  a  residence  of  six  months  he  becomes  charge- 
able with  the  duties  for  the  year  commencing  on  April  6th  pre- 
ceding. 

8T.  D.  2242. 

9  T.  D.  2242.  The  certificate  to  be  used  is  known  officially  as 
Form  1078. 


INDIVIDUALS    TO    \\HOM    LAW    IS    APPLICABLE  25 

within  the  United  States,  including  interest  on  bonds, 
notes  or  other  interest-bearing  obligations  of  residents, 
corporate  or  otherwise.  If  a  non-resident  alien  con- 
ducts business  through  an  agent  in  this  country,  the 
agent  will  be  subject  to  the  duty  of  filing  a  return  for 
his  non-resident  principal  and  of  paying  both  the  normal 
and  the  supertaxes.*" 

Husband  and  Wife.  In  so  far  as  possible  the  family 
is  treated  as  a  unit  for  the  purpose  of  the  income  tax, 
and  husband  and  wife  are  required  to  make  joint  returns 
unless  they  have  separate  estates.  The  personal  exemp- 
tion is  in  such  cases  deducted  from  the  joint  income, 
but  the  surtax  is  in  all  cases  imposed  upon  the  separate 
incomes.** 

Minors.  Minors  are  unable  to  make  returns  for 
themselves,  and  such  returns  are  required  to  be  made 
by  their  guardians.**  If  the  minor  has  a  separate  legal 
estate  a  separate  return  is  made  of  his  income,  but 
where  a  minor  child  has  received  gifts  of  money  and 
other  property  from  relatives  and  the  property  has 
l)een  invested  on  behalf  of  the  child  by  the  father, 
although  he  has  not  been  legally  appointed  guardian, 
the  amount  should  be  included  in  the  return  made 
by  the  father  as  a  part  of  his  (the  father's)  income.*' 

10  See  Chapter  6  on  agents  for  non-resident  aliens. 

11  T.  D.  2090. 

18  Reg.  .S3,  Art.  17. 

18  Letter  from  Treasury  Department  dated  October  20,  1916; 
I.  T.  S.  1917,  1248.  This  ruling  is  made  apparently  to  prevent 
fvasion  of  the  law  by  distributing  the  income  of  the  parent 
among  his  minor  children. ' 


26  FEDERAL   INCOME  TAX 

Incompetents.  Incompetent  or  insane  persons  are 
unable  to  make  their  own  returns  of  net  income,  and 
the  same  are  required  to  be  made  by  the  duly  author- 
ized agent,  guardian  or  committee  having  charge  of 
such  incompetent  or  insane  person.^* 

Absentees.  Where  a  persons  is  absent  from  the 
country  or  is  a  non-resident  and  is  unable  to  make  the 
return  of  annual  net  income  it  may  be  made  for  him 
by  an  agent,  the  agent  assuming  the  responsibility  of 
making  the  return  and  incurring  penalties  provided  for 
erroneous,  false  or  fraudulent  returns.^^ 

Agents.  Any  person  duly  authorized  and  having 
knowledge  of  the  income  of  another  may  file  returns 
for  bis  principal  and  pay  the  tax  based  thereon.  The 
intent  and  purpose  of  the  act  is  "that  all  gains,  profits 
and  income  of  a  taxable  class,"  as  defined  by  the  law, 
shall  be  charged  and  assessed  with  the  corresponding 
tax,  normal  and  supertax,  prescribed  by  the  law,  and 
the  tax  shall  be  paid  by  the  owner  of  such  income  or 
the  proper  representative  having  the  receipt,  custody, 
control  or  disposal  of  the  same.^®  Persons  having  the 
control  and  custody  of  income  of  non-resident  aliens 
may,  without  having  been  appointed  by  the  principal, 
be  charged  with  the  duty  of  making  a  return  and  paying 
the  tax  on  the  income  passing  through  their  hands.^"' 

»' 

Fiduciaries.  Trustees,  executors,  administ|*ators  and 
other  persons  acting  in  a  fiduciary  capacity  are  charged 

14Eeg.  33,  Art.  17. 

16  Act  of  September  8,  1916,  §  8  (b). 

16  Act  of  September  8,  1916,  §9  (g). 

17  See  Chapter  6  for  duties  of  agents  of  non-residecti. 


INDIVIDUALS    TO    WHOM    LAW    IS    APPLICABLE  27 

with  special  duties  under  the  law.     These  duties  are 
fully  discussed  in  the  chapter  on  fiduciaries.^* 

Persons  Dying  During  the  Year.  When  a  person  dies 
during  any  calendar  year  it  is  the  duty  of  the  executor 
or  administrator  or  person  taking  charge  of  his  prop- 
erty to  make  a  return  for  the, deceased  from  the  begin- 
ning of  the  year  to  the  date  of  death.  In  this  return 
should  be  reported  all  of  the  income  received  up  to 
the  time  of  death  and  all  the  allowable  deductions 
incurred  up  to  that  time.  The  personal  exemption 
may  be  claimed  in  full  according  to  the  status  of  the 
decedent  and  regardless  of  the  length  of  time  during 
the  year  in  which  he  lived.  In  case  the  decedent  dies 
after  the  close  of  the  calendar  year,  but  before  March 
1st  of  the  following  year,  and  has  not  made  a  return 
for  the  preceding  calendar  year  a  return  should  be 
made  for  the  full  year  preceding  and  in  addition  a 
return  from  January  1  of  the  current  year  to  the 
date  of  death.  If  during  the  period  in  which  the 
decedent  lived  Jie  was  not  in  receipt  of  $1,000  of  net 
income,  if  unmarried,  or  $2,000,  if  married,  no  return 
need  be  filed,  unless  he  was  a  non-resident  alien,  in  which 
case  a  return  should  be  filed,  whether  married  or  single, 
if  the  amount  is  $1,000  or  more.  The  fact  that  a  person 
may  have  died  before  the  passage  of  the  law  does  not 
relieve  his  estate  of  liability  for  tax,  if  he  lived  during 
any  part  of  the  time  after  the  incidence  of  the  tax. 
Thus  a  person  dying  after  March  1,  1913,  but  before 
October  3,  1913,  the  date  on  which  the  1913  Law  was 
passed,  was  held  to  be  taxable  thereunder.  The  effect 
of  making  the  act  retroactive  is  to  apply  it  to  him 

!■  See  Chapter  8. 


28  FEDERAL   INCOME   TAX 

exactly  as  if  it  had  been  enacted  on  March  1,  1913.^^ 
Similarly  if  a  person  dies  at  any  timei  after  the  1st  of 
January,  19J7,  his  estate  will  be  subject  to  the  tax  im- 
posed by  the  1917  Law. 

19  Brady  v.  Anderson,  240  Fed.  665. 


CHAPTER  4 

CITIZENS  AND  RESIDENTS  OP  THE  UNITED  STATES 

All  citizens  of  this  country,  residing  here  or  elsewhere, 
and  all  residents  of  this  country,  whether  citizens  or 
not,  are  classed  together  for  the  purpose  of  the  income 
tax.i 

Extent  to  Which  Taxable.  Citizens  and  residents 
are  taxable  upon  their  entire  net  income  received  in 
each  calendar  year  from  all  sources,  except  income 
declared  by  the  law  to  be  exempt.  On  dividends  of 
corporations  taxable  under  the  act  they  are  liable  only 
for  supertaxes.  The  regulations  and  rulings  respecting 
taxable  and  non-taxable  income  are  applicable  to  both 
individuals  and  corporations  and  are  discussed  in  the 
later  chapters  on  income.* 

Deductions  and  Exemptions  Allowed.  Citizens  and 
residents  are  allowed  the  following  deductions  in  com- 
puting net  income  for  the  purpose  of  the  tax.  Many 
of  the  deductions  are  the  same  as  those  permitted  to 
corporations  and  in  such  cases  the  deduction  is  fully 
discussed  in  a  subsequent  chapter.  In  this  chapter  only 
the  special  provisions  applicable  to  individuals  are  dis- 
cussed at  length. 

1  See  preceding  Chapter  for  definition  of  citizens  and  residents. 
*  See  Chapters  16  to  26  on  income. 


30  FEDERAL   INCOME  TAX 

Business  Expenses.  An  individual  may  deduct  from 
his  gross  income  all  necessary  expenses  actually  paid  in 
carrying  on  any  business  or  trade  but  may  not  deduct 
personal  living  or  family  expenses.'  A  subsequent  para- 
graph of  this  chapter  defines  what  is  held  by  the  Depart- 
ment to  be  the  meaning  of  the  words  "business  or 
trade." 

Buildings  Used  for  Rental  Purposes.  A  landlord 
may  claim  as  an  expense  any  amounts  for  maintenance 
of  the  property  or  its  use  for  rental  purposes,  including 
amounts  paid  for  repairs,  insurance,  fuel,  light  and 
water,  and  janitor  and  elevator  service,  if  any.*  Where 
the  landlord  occupies  a  part  of  the  building  as  his  own 
dwelling  he  should  not  deduct  such  proportion  of  the 
expenses  of  operating  the  building  as  inure  to  his  per- 
sonal benefit,  as  that  part  constitutes  personal  or  living 
expenses  which  are  not  deductible.  Thus,  if  a  landlord 
lives  in  one-half  of  the  building,  one-half  of  the  expenses 
are  not  allowable  deductions  in  his  return. 

Personal  Living  or  Family  Expenses.  The  personal 
living  or  family  expenses  which  are  not  deductible  under 
the  law  are  intended  to  be  those  which  are  not  incurred 
by  the  taxpayer  in  carrying  on  his  business  or  trade. 
They  include,  for  example,  the  expense  of  maintaining 
his  home,  payments  to  his  servants,  payments  for  the 
support  and  education  of  his  children.  Premiums  paid 
for  insurance  on  property  occupied  by  the  owner  as 
a  dwelling  are  a  personal  expense  and  not  allowed  as 

8  The  personal  exemptions  may  be  said  to  be  an  arbitrary  sum 
allowed  for  such  expenses. 

4  Letter  from  Treasury  Department  dated  Pebmary  26,  1915; 
I.  T.  S.  1917,  If  224. 


CITIZENS  AND  RESIDENTS  OF  UNITED  STATES  31 

a  deduction.  Premiums  paid  on  life  insurance  by  the 
insured  are  also  not  allowed  as  a  deduction.*  ^imony 
is  regarded  as  a  personal  expense  and  is  not  an  allow- 
able deduction.® 

Interest.  A  citizen  or  resident  may,  with  one  excep- 
tion, deduct  all  interest  paid  within  the  year  on  his 
indebtedness.''  This  includes  not  only  indebtedness 
incurred  for  business  purposes,  but  indebtedness  incurred 
for  any  purpose,  such  as  for  the  purpose  of  buying  a 
dwelling  house  or  any  article  or  thing  of  personal  use. 
The  one  limitation  on  the  amount  of  interest  which  may 
be  deducted  is  with  respect  to  interest  paid  on  indebted- 
ness incurred  for  the  purchase  of  obligations  or  securi- 
ties, the  interest  upon  which  is  exempt  from  taxation 
as  income  of  the  individuiil.* 

Taxes.  Citizens  or  residents  may  deduct  all  taxes 
paid  within  the  year  imposed  by  the  authority  of  any 
territory  or  possession  of  the  United  States,  or  any 
foreign  country,  or  under  the  authority  of  any  state, 
county,  school  district  or  municipality  or  other  taxing 
subdivision  of  any  state.  Taxes  assessed  against  local 
benefits,  however,  may  not  be  deducted.  Taxes  imposed 
by  the  United  States  may  be  deducted,  except  income 
taxes  and  excess  profits  taxes.  Inheritance  taxes  are 
held  not  to  be  taxes  contemplated  by  this  provision  of 
the  law.® 

6T.  D.  2090. 

8  T.  D.  2090. 

7  Telegram    from    Treasury    Department    dated    February    16, 
1915. 
>  For  a  further  discussion  of  this  subject  see  Chapter  29. 

9  For  a  further  discussion  of  the  rules  relating  to  tha  deduction 
of  taxes  see  Chapter  30. 


32  FEDERAL   INCOME   TAX 

Losses  Incurred  in  Trade.  Citizens  and  residents 
may  deduct  losses  actually  sustained  during  the  year 
incurred  in  business  or  trade.  A  loss  incurred  in  busi- 
ness or  trade  must  be  an  absolute  loss,  not  a  speculative 
or  fluctuating  valuation  of  a  continuing  investment,  but 
must  be  determined  and  ascertained  upon  an  actual, 
a  completed,  a  closed  transaction.^® 

Business  or  Trade.  Business  or  trade  has  been  de- 
fined as  being  synonymous  terms  and  to  be  "  That  which 
occupies  and  engages  the  time,  attention  and  labor  of 
anyone  for  the  purpose  of  livelihood,  profit,  or  improve- 
ment ;  that  which  is  his  personal  concern  or  interest ; 
employment,  regular  occupation,  but  it  is  not  necessary 
that  it  should  be  his  sole  occupation  or  employment." 
The  doing  of  a  single  act  incidentally  or  of  necessity 
not  pertaining  to  the  .particular  business  of  the  person 
doing  the  same  will  not  be  considered  engaging  in  or 
carrying  on  business."  *'In  trade"  as  used  in  the  law 
is  held  to  mean  the  trade  or  trades  in  which  the  person 
making  the  return  is  engaged;  that  is,  in  which  he  has 
invested  money,  otherwise  than  for  the  purpose  of  being 
employed  in  isolated  transactions,  and  to  which  he 
devotes  at  least  a  part  of  his  time  and  attention.  A 
person  may  be  engaged  in  more  than  one  trade  and  may 
deduct  losses  incurred  in  all  of  them,  provided  that  in 
each  trade  the  above  requirements  are  met.  Losses  on 
stocks,  grain,  cotton,  etc.,  may  be  deducted  by  a  person 
engaged  in  the  trade  to  which  the  buying  or  selling 
thereof  are  incident  as  a  part  of  the  business,  as  by  a 
member  of  a   stock,  grain,   or  cotton   exchange,^*  but 

10  T.  D.  1989.  Depreciation  in  the  value  of  property  is  treated 
as  a  separate  deduction  and  should  not  be  confused   with  loss. 

11  T.  D.  1989. 

12  T.  D.  2090. 


CITIZENS   AND   KliiilUENTS   OK   UNITED   STATES  33 

neither  the  investment  of  money  in  the  stock  of  a  com- 
pany nor  employment  by  the  company  in  any  official 
capacity  makes  the  business  of  the  company  the  trade 
of  the  investor  or  employee.*'  The  losses  which  seem 
to  be  limited  by  this  provision  of  the  law  are  those 
incurred  in  transactions  involving  sales  or  dealings  in 
property.  The  law  seems  clearly  to  make  a  distinction 
between  such  losses  and  losses  arising  from  fires,  storms, 
shipwreck,  or  other  casualty,  and  from  theft. 

Losses  of  Property  from  Fire,  Storms,  Etc.  The  law 
does  not  require  that  the  property  lost  by  fires,  storms, 
shipwreck,  or  other  casualty,  or  from  theft,  should  be 
properly  employed  in  the  business  or  trade  of  the  indi- 
vidual, but  the  Treasury  Department  seems  to  hold 
that  even  such  losses  must  be  sustained  in  trade.**  It 
seems  to  have  been  the  intent  of  Congress,  however,  to 
permit  the  deduction  of  these  losses  by  citizens  or  resi- 
dents to  the  extent  that  the  losses  are  not  compensated 
for  by  insurance  or  otherwise.** 

Losses  Not  Incurred  in  Trade.  In  transactions  en- 
tered into  for  profit  but  not  connected  with  his  business 
or  trade,  a  citizen  or  resident  may  deduct  the  losses 

13  T.  D.  2135.  This  extremely  narrow  construction  of  the 
language  of  the  law  has  perhaps  been  the  subject  of  more  criti- 
cism than  any  other  ruling  of  the  Treasury  Department.  It 
operates  to  the  detriment  of  every  person  who  invests  or  specu- 
lates in  property.  Notwithstanding  the  criticism,  however, 
Congress  has  not  seen  fit  to  remedy  the  injustice  by  permitting 
the  deduction  of  all  losses  in  transactions  on  which  the  gain,  it' 
any,  is  taxable. 

14  T.  D.  2005. 

16  Act  of  September  8,  1916,  {5  (a).    For  a  further  discussion 
of  the  subject  of  losses  see  Chapter  31. 
F.  T.  Tax.--3 


34  FEDERAL    INCOME   TAX 

actually  sustained  therein  during  the  year  to  an  amount 
not  exceeding  the  profits  arising  therefrom.  The  loss 
must  be  actually  sustained  during  the  year  and  the 
total  amount  which  may  be  deducted  shall  not  exceed 
the  profits  arising  from  the  same  class  of  transactions.^* 
Under  this  heading  an  individual  who  makes  invest- 
ments in  property  from  time  to  time,  or  who  speculates, 
is  required  to  report  all  of  the  gains  from  such  invest- 
ments or  speculations  and  may  offset  against  the  gains 
all  losses  which  he  has  sustained  in  similar  transactions. 
He  is  thus  required  to  report  only  the  net  gain  from 
such  transactions  during  the  year.  If,  however,  the  net 
result  for  the  year  of  a  series  of  such  transactions  is 
a  loss,  he  is  not  entitled  to  offset  the  loss  against  his 
income  from  buiness  or  trade.^'' 

Worthless  Debts.  A  citizen  or  resident  may  deduct 
all  debts  due  to  him  actually  ascertained  to  be  worth- 
less and  charged  off  within  the  year.  The  law  does  not 
require  such  debts  to  have  been  incurred  in  the  business 
or  trade  of  the  individual.  It  is  sufficient  if  a  debt 
was  legally  due  and  owing  to  the  taxpayer,  has  actually 

le  Act  of  September  8,  1916,  §  5. 

17  Prior  to  the  passage  of  the  Act  of  September  8,  1916,  author- 
izing the  deduction  of  losses  not  incurred  in  trade  to  the  extent 
indicated  above,  it  was  held  by  the  Treasury  Department  that 
an  individual  was  required  to  report  all  income  from  transactions 
not  incurred  in  trade  but  was  not  entitled  to  deduct  any  of  the 
losses.  Thus,  if  on  a  series  of  transactions  during  the  year  a 
gain  of  $5,000  was  made,  and  $4,000  was  lost,  the  sum  of  $5,000 
was  to  be  reported  as  income  and  no  deduction  could  be  made 
for  the  loss.  T.  D.  2135.  Under  the  present  law  the  taxpayer 
pays  the  tax  only. upon  the  net  gain  of  $1,000.  Logically,  since 
the  law  taxes  all  gains  from  the  sale  of  capital  assets  whether  or 
not  employed  in  business  or  trade,  the  law  ought  also  to  permit 
a  deduction  for  all  losses  in  the  sale  of  similar  assets. 


OlTLiEWS    AND    KKSIDENTS   OF    UNITED   STATES  35 

been  ascertained  to  be  worthless  and  has  been  charged 
off  within  the  year.*' 

Depreciation.  An  individual  is  allowed  a  reasonable 
deduction  for  exhaustion,  wear  and  tear  of  property 
arising  out  of  its  use  or  employment  in  his  business 
or  trade.  It  is  to  be  noted  that  this  deduction  applies 
expressly  to  property  used  in  the  individual's  business 
or  trade.  No  allowance  for  depreciation  can  be  claimed 
upon  other  property,  such  as  the  individual's  residence 
or  his  pleasure  automobile.  This  limitation  applies 
expressly  to  individuals.  In  other  respects  the  provi- 
sions for  allowing  depreciation  in  the  ease  of  individuals 
and  corporations  are  the  sdme,  and  are  treated  in  a 
subsequent  chapter  on  depreciation.^® 

Depletion  of  Natural  Resources.  Individuals  are 
permitted  the  same  allowance  for  the  exhaustion  of 
natural  resources  as  is  allowed  to  corporations  in  the 
case  of  oil  wells,  gas  wells  and  mines.  This  subject  is 
discussed  in  subsequent  chapters.^ 

Improvements  and  Betterments.  Xo  deduction  is 
allowed  for  amounts  expended  for  new  buildings,  per- 
manent improvements  or  betterments  made  to  increase 
the  value  of  any  property  or  estate  and  no  deduction 
is  allowed  for  any  amount  expended  for  restoring  prop- 
erty or  making  good  the  exhaustion  thereof  for  which 
an  allowance  has  been  made.  This  limitation  on  the 
deductions  allowed  to  individuals  is  the  same  as  in  the 

18  See  Chapter  .31  for  a  further  discussion  on  the  deduction 
of  worthless  debts. 

19  See  Chapter  32  on  Depreciation. 
80  See  Chapters  .3.3  and  .34. 


36  FEDERAL  INCOME   TAX 

case  of  corporations,  and  is  a  reasonable  limitation. 
Amounts  of  capital  invested  in  permanent  improvements 
or  betterments  add  to  the  value  of  the  property.  If 
such  property  is  subject  to  wear  and  tear  or  depletion 
the  additional  amount  so  invested  in  the  property  may 
be  taken  into  consideration  in  computing  the  allowance 
for  depreciation  or  depletion.  This  subject  is  more 
fully  discussed  in  a  subsequent  chapter.*^ 

Contributions  to  Charities.  A  citizen  or  resident  is 
allowed  to  deduct  from  his  net  income  contributions 
or  gifts  actually  made  within  the  year  to  corporations 
or  associations  organized  and  operated  exclusively  for 
religious,  charitable,  scientific  or  educational  purposes, 
or  to  societies  for  the  prevention  of  cruelty  to  children 
or  animals,  no  part  of  the  net  income  of  which  inures 
to  the  benefit  of  any  private  stockholder  or  individual. 
This  deduction,  however,  is  limited  to  an  amount  not 
in  excess  of  15%  of  the  taxpayer's  taxable  net  income 
including  the  amount  of  such  contributions.  The  law 
further  provides  that  such  contributions  or  gifts  shall 
be  allowable  as  deductions  only  if  verified  under  rules 
and  regulations  prescribed  by  the  Treasury  Department. 
The  deduction  is  not  allowed  to  non-resident  aliens  or 
corporations.^^ 

Credit  of  Dividends.  For  the  purpose  of  computing 
the  normal  tax  the  individual  may  also  deduct  from  his 
net  income  the  amount  received  as  dividends  upon  the 
stock  or  from  the  net  earnings  of  any  .corporation  tax- 
able upon  its  net  income  under  the  law.  The  dividends 
intended  to  be  included  in  this  provision  of  the  law  are 

81  See  Chapter  27. 

22  Act  of  Sept.  8,  1916,  as  amended,  §  5. 


CITIZENS   AND   RESIDENTS   OP   UNITED   STATES  37 

apparently  those  of  domestic  corporations  and  also  those 
of  foreign  corporations,  if  the  foreign  corporation  is 
within  this  country  and  is  taxable  upon  its  net  income. 
The  amount  of  such  dividends  is  deductible  only  for  the 
purpose  of  assessing  the  normal  tax,  and  not  for  the 
supertax." 

Personal  Exemption.  The  personal  exemption  is 
allowed  only  to  citizens  and  residents.  A  non-resident 
alien  or  a  corporation  has  no  right  to  claim  this  ex- 
emption. In  the  case  of  unmarried  citizens  or  residents 
the  amount  of  the  exemption  is  $3,000  under  the  1916 
Law,  and  $1,000  under  the  1917  Law.  In  the  case  of 
married  persons  living  together,  the  exemption  is  $4,000, 
under  the  1916  Law  and  $2,000  under  the  1917  Law.  In 
the  case  of  the  head  of  a  family  it  is  also  $4,000  and 
$2,000  under  the  respective  laws.  If  the  person  making 
the  return  is  the  head  of  a  family  there  is  an  addi- 
tional exemption  of  $200  for  each  child  dependent  upon 
such  person,  if  under  18  years  of  age,  or  if  incapable  of 
self-support  because  mentally  or  physically  defective. 
This  deduction,  of  course,  can  be  claimed  only  by  one 
parent  in  a  family.  The  same  allowance  for  dependent 
children  may  be  claimed  under  each  law.** 

Guardians  and  Trustees.  Guardians  or  trustees  are 
allowed  this  personal  exemption,  as  to  income  derived 
from  the  property  of  which  such  guardian  or  trustee 
has  charge,  in  favor  of  each  ward  or  cestui  que  trvst, 
the  amount  of  exemption  depending,  of  course,  on  the 
single  or  married  status  of  the  ward  or  cestui  que  trust 
and  the  existence  of  dependent  children.    In  no  event, 

as  Act  of  September  8,  1916,  Sec.  5  (b). 

M  Act  of  September  8,  1916,  §  7,  as  amended.    T.  D.  2547. 


38  FEDERAL,   INCOME   TAJi 

however,  is  a  ward  or  cestui  que  trust  allowed  a  greater 
personal  exemption  than  is  provided  in  the  law  from  the 
amount  of  net  income  received  from  all  sources.  That 
is,  if  such  ward  or  beneficiary  claims  the  personal  exemp- 
tion through  the  trustee  it  cannot  again  be  claimed 
against  the  income  from  other  sources. 

Estates  of  Deceased  Persons.  In  the  case  of  estates 
of  deceased  citizens  or  residents  of  the  United  States  a 
specific  exemption  is  allowed,  in  addition  to  the  other 
deductions,  during  the  period  of  administration  or  set- 
tlement. That  is,  from  the  net  income  of  each  year 
during  which  the  estate  is  in  the  course  of  settlement, 
and  is  consequently  taxed  as  an  entity,  a  specific  ex- 
emption of  $3,000  may  be  deducted  in  addition  to  all 
other  deductions,  for  the  purpose  of  assessing  the  1916 
normal  tax  and  $1,000  the  purpose  of  assessing  1917  tax. 

Trusts  and  Other  Estates.  Trusts  or  other  estates 
of  citizens  or  residents  of  the  United  States  are  required, 
through  the  trustees,  to  pay  a  tax  upon  all  undistributed 
income.  From  the  amount  of  such  undistributed  income, 
may  be  deducted  a  specific  exemption  of  $3,000,  for 
the  purpose  of  assessing  the  1916  normal  tax  and  $1,000 
for  the  purpose  of  assessing  the  1917  normal  tax. 

Head  of  Family.  This  phrase  in  the  law  is  defined 
to  include  any  person  who  actually  supports  and  main- 
tains one  or  more  individuals  who  are  closely  connected 
with  him  (or  her)  by  blood  relationship,  relationship  by 
marriage,  or  by  adoption,  and  whose  right  to  exercise 
family  control  and  provide  for  these  dependent  indi- 
viduals is  based  upon  some  moral  or  legal  obligation.'** 

25  T.  D.  2427. 


CITIZENS   AND    RESIDENTS   OF    UNITED   STATES  39 

Such  head  of  a  family  is  entitled  to  the  same  personal 
exemption  as  married  persons.  As  indicated  by  the 
above  definition  the  head  of  a  family  may  be  a  single 
or  married  person,  a  widow,  widower,  brother,  sister  or 
other  relative  by  blood,  marriage  or  adoption. 

Husband  and  Wife.  A  husband  and  wife  living 
together  are  entitled  under  the  1916  Law  to  an  exemp- 
tion of  $4,000  only,  and  under  the  1917  Law  to  an 
exemption  of  $2,000  oiily,  from  the  aggregate  net  in- 
come of  both.*®  If  they  live  apart  each  may  claim  the 
exemptions  allowed  to  single  persons.  The  personal 
exemption  may  be  claimed  in  a  separate  return  of  either 
husband  or  wife,  the  other  claiming  no  exemption;  or 
may  be  prorated  between  the  two.*'' 

r 

Status  of  Claimant.  The  status  (single,  married  or 
head  of  a  family)  of  the  person  claiming  the  personal 
exemption  is  determined  as  of  the  close  of  the  year.** 
Thus  where  either  husband  or  wife  dies  during  the  year, 
the  survivor,  in  making  a  return  at  the  end  of  the  year, 
will  be  allowed  ♦the  exemption  applicable  to  single  per- 
sons or  heads  of  families,  and  the  executor  or  adminis- 
trator of  the  deceased,  in  making  a  return  for  the  de- 
ceased, may  claim  the  exemption  according  to  the  status 
of  the  deceased  at  the  time  of  his  death,  from  the  net 
income  received  between  the  first  of  the  year  and  the 
date  of  death  no  matter  how  short  the  period.*®  The 
personal  exemption  is  not  prorated  where  a  return  is 
made  for  a  period  shorter  than  the  full  year. 

MBeg.  33,  Art  10. 
t7T.  D.  2137. 
28  Reg.  33,  Art.  10. 
»T.  D.  2090,  T.  D.  213.'i 


40  FEDERAL  INCOME  TAX 

Not  Applicable  to  Supertax.  The  personal  exemp- 
tion is  not  to  be  deducted  from  the  net  income  of  the  indi- 
vidual in  assessing  the  supertax.^® 

Tax  Not  Withheld  at  Source.  The  tax  is  not  with- 
held at  the  source  on  payments  to  citizens  and  residents.  , 
A  provision  of  the  law  requires  withholding  at  the  source 
in  the  case  of  corporate  bonds  and  mortgages  containing 
a  so-called  "tax-free  covenant."  This,  however,  is  not 
intended  as  a  provision  requiring  withholding,  but  is 
intended  to  require  the  corporation  to  assume  the  burden  » 
of  a  part  of  the  tax  for  the  bondholder.  Consequently 
in  such  cases  no  tax  is  actually  deducted,  but  the  cor- 
poration assrumes  for  the  bondholder  the  payment  of  one 
2%  normal  tax,  which  amount  the  bondholder  reports  as 
though  the  tax  had  been  actually  withheld.  The  other 
2%  normal  tax  being  reported  as  not  having  been  with- 
held. For  a  further  discussion  of  collection  at  the  source 
see  the  chapter  on  that  subject.^^ 

Duty  in  MaJdng  Payment  of  Income.  All  citizens 
and  resider.ts  are  subject  to  the  provisions  of  law  re- 
quirirg  the  reporting  of  names  and  addresses  of  individ- 
uals to  whom  fixed  and  determinable  inco.ne  is  paid. 
For  a  further  discussion  of  the  duties  in  this  connection 
see  the  chapter  on  Information  at  the  Source.  If  pay- 
ments of  fixed  or  determinable  income  are  made  to  non- 
resident aliens,  the  normal  tax  imposed  by  the  1916  Law 
is  required  to  be  withheld.^^ 

so  Cohen  v.  Lowe,  234  Fed.  474. 

SI  See  Chapter  41. 

82  See  Chapters  40  and  41. 


CHAPTER  5 

NON-RESIDENT   ALIENS 

The  law  imposes  a  tax  on  the  entire  net  income  re- 
ceived "from  all  sources  within  the  United  States  by 
every  individual  a  non-resident  alien,  including  interest 
on  bonds,  notes,  or  other  interest-bearing  obligations 
of  residents,  corporate  or  otherwise."  ^  The  term  "non- 
resident alien"  as  used  in  several  places  in  the  law 
is  not  defined  therein,  but  clearly  refers  to  individuals 
only,  and  not  to  partnerships,  corporations  or  associa- 
tions. Ordinarily  it  is  a  simple  matter  to  determine 
whether  an  individual  is  or  is  not  a  non-resident  alien ; 
he  falls  into  that  class  if  he  is  neither  a  citizen  nor 
a  resident.  Difficulty  may  arise  where  a  non-resident 
citizen,  naturalized  or  native,  has  resided  abroad  for 
a  period  so  long  as  to  raise  a  presumption  that  he  has 
abandoned  his  citizenship,*  and  again  where  an  alien 
has  resided  in  this  country  for  a  period  so  long  as  to 
raise  a  presumption  of  residence.  In  either  of  these 
cases  the  intent  of  the  individual  is  important.  The 
Treasury  Department  holds  that  the  status  of  a  non- 
resident native  or  naturalized  citizen  remains  unchanged 
until  some  affirmative  action  is  taken,  or  the  right  to 

1  Act  of  Septomber  8,  1916,  §  1. 

8  The  Act  of  March  2,  1907,  provides,  hriefly,  that  any  American 
citizen  becomes  an  aV.en  by  becoming  naturalized  in  a  foreign  state 
or  taMng  an  oath  of  allegiance  to  any  foreign  state.    A  naturalized 

41 


42  FEDERAL   mcOME   TAX 

citizenship  is  forfeited  by  some  overt  act.^  The  mere 
fact  of  continued  absence  from  this  country  does  not, 
for  purpose  of  income  tax,  necessarily  establish  any 
presumption  of  expatriation. 

On  the  other  hand,  an  alien  coming  to  the  United 
States  with  the  intention  of  becoming  a  resident  within 
the  meaning  and  intent  of  the  income  tax  statute,  may 
indicate  that  fact  and  thereupon  will  be  taxed  as  a 
resident,  regardless  of  the  length  of  time  he  has  been 
here.*  Where  the  expectation  or  intention  of  an  alien 
is  to  leave  the  United  States  upon  the  termination  of 
the  employment,  or  accomplishment  of  the  purpose, 
which  necessitates  his  presence  in  this  country,  he  will 
be  considered  as  a  non-resident  alien  although  he  may 
temporarily  reside  here  for  a  season  or  other  similarly 
definite  term.^  The  length  of  residence  is  in  jtself  no 
determining  factor,  and  he  may  under  the  present 
regulations  remain   in   this   country   during  an   entire 

citizen,  residing  for  two  years  in  the  country  from  which  he  came, 
or  for  five  years  in  any  other  foreign  country,  is  presumed  to 
have  renounced  his  American  citizenship  in  the  absence  of  satis- 
factory evidence  to  the  contrary.  A  woman  assumes  the  nationality 
of  her  husband,  but  may  resume  her  original  citizenship  on  be- 
coming a  widow;  she  assumes  or  retains  her  American  citizenship 
as  a  widow  if,  living  abroad,  she  registers  with  a  United  States 
consul,  or  without  formal  action  if  she  resides  here.  Minor  chil- 
dren of  naturalized  citizens  are  deemed  to  be  citizens  from  the 
time  they  begin  to  reside  permanently  in  this  country.  Children 
born  outside  of  the  United  States  of  citizens,  and  continuing  to 
reside  abroad  must  at  the  age  of  18  declare  their  intention  as  to 
citizenship.  Determination  of  citizenship  by  the  State  Department 
under  this  Act  is  mot  conclusive  upon  the  Treasury  Department ; 
other  factors  may  also  be  Considered,  as  indicated  in  the  text. 

ST.  D.  2135. 

4  T.  D.  2242.    See  Chapter  2  for  status  of  resident  aliens. 

6  T.  D.  2242. 


NON-HliSiDENT   AiJENS  43 

tax  year  without  necessarily  losing  his  status  as  a  non- 
resident alien.  Should  he  go  to  the  extent  of  locating 
his  principal  business  establishment  here  or  accept  occu- 
pation or  employment  of  a  permanent  character  in  this 
country  he  will  be  held  to  be  a  resident,  although  his 
domicile  may  be  witfiout  the  United  States.* 

Extent  to  Which  Non-Resident  Aliens  Are  Taxable. 

The  1916  Law  provides  that  non-resident  aliens  shall 
pay  the  normal  tax  and  supertax  thereby  imposed  "^  on 
their  entire  net  income  received  from  all  sources  within 
the  United  States,  including  interest  on  bonds,  notes 
or  other  interest-bearing  obligations,  of  residents,  corpo- 
rate or  otherwise.*  The  1917  Law  imposes  no  normal  tax 
on  non-resident  aliens,  but  imposes  a  supertax.  At 
present,  therefore,  a  non-resident  alien  is  subject  to 
a  normal  tax  of  2%  and  two  supertaxes — that  of  the 
1916  Law  and  that  of  the  1917  Law — on  income  received 
from  sources  within  the  United  States. 

Income  from  Sources  Within  the  United  States.  The 
words  "sources  within  the  United  States"  are  not  defined 

6T.  D.  2242. 

7  See  Chapter  1  for  the  rates. 

8  The  1913  Law  which  was  repealed  by  the  1916  Law,  imposed 
a  tax  on  the  net  income  of  non-resident  aliens  "from  all  property 
owned  and  every  business,  trade  or  profession  carried  on  in  the 
United  States."  This  language  was  held,  under  two  opinions  of 
the  Attorney  General,  not  to  include  interest  or  dividends  received 
hy  non-resident  alien  investors  from  domestic  corporations,  but 
on  March  21,  1916  the  Treasury  Department  reversed  this  holding 
and  thereafter  claimed  the  tax  from  non-resident  aliens  on  the 
classes  of  income  in  question.  T.  D.  2313.  In  DeGanay  v.  Lederer, 
239  Fed.  568,  the  District  Court  held  a  non-resident  alien  taxable 
on  such  income  if  the  stock  certificates  and  bonds  were  kept  in 
this  country,  as  then  they  acquired  a  situs  here  for  purpose  of 
the  income  tax.  The  language  of  the  1916  Law  expressly  includes 
ouch  income,  regardless  of  whero  the  securities  may  be  kept. 


44  /        FEDERAL.  INCOME  TAX 

in  the  law  and  their  interpretation  raises  many  difficult 
questions.  The  term  is  very  broad  and  was  intended 
to  include  income  of  all  kinds  from  sources  over  which 
this  country  has  jurisdiction.  No  cases  as  yet  have 
arisen  in  the  courts  involving  construction  of  the  phrase 
and  the  Treasury  Department  has  not  issued  any  com- 
prehensive ruling  deiining  "source."  The  term  "in- 
come" includes  any  income,  gains  or  profits  from  prop- 
erty owned  or  business,  trade  or  profession  carried  on 
in  this  country,  dividends,  interest,  royalties,  income 
from  property  held  in  trust,  income  from  partnership 
profits,  income  from  profits  or  gains  on  the  sale  of  prop- 
erty, and  as  further  defined  in  the  1916  Law.  Non- 
resident aliens  are  not  taxed  on  income  specified  in 
the  law  as  exempt.® 

Income  from  Business  Branches.  Where  a  non- 
resident alien  establishes  a  branch  of  his  business  in 
this  country  the  net  income  of  that  branch  is  subject 
to  tax,  and  this  would  seem  to  be  true  even  though  a 
portion  of  that  income  may  have  been  received  by  the 
branch  from  business  done  in  foreign  countries,  although 
the  precise  point  is  as  yet  unsettled.  If  two  or  more 
branches  are  established  here,  the  total  net  income  from 
all  is  taken  together  for  purpose  of  assessment.  The 
income  of  all  branches  should  be  reported  by  the  prin- 
cipal branch  in  its  district,  the  other  branches  not  being 
assessable  in  their  respective  districts.^® 

Dividends.  Non-resident  aliens  are  not  subject  to  the 
normal  tax  on  income  in  the  form  of  dividends  of  eor- 

0  See  the  Chapters  on  Income. 

10  Generally,  the  rules  applying  to  foreign  corporations  as  to 
income  from  business  done  in  this  country  apply  equally  to  non- 


NON-RESIDENT   ALIENS  45 

porations  taxable  under  the  law  on  their  net  incomes, 
if  a  return  of  annual  net  income  is  filed,  but  the  amount 
of  such  dividends  must  be  reported  in  the  return.  If 
the  total  income  of  all  kinds  from  sources  within  the 
United  States,  including  dividends,  exceeds  $5,000  the 
supertax  imposed  by  the  1917  Law  must  be  paid  at 
the  prescribed  rates,  and  if  it  exceeds  $20,000,  the  super- 
tax imposed  by  the  1916  Law  must  also  be  paid  at  the 
prescribed  rates.**  The  exemption  of  dividends  from 
the  normal  tax  applies  not  only  to  dividends  received 
direct  from  the  corporation,  but  also  to  dividends  re- 
ceived through  the  medium  of  fiduciaries  or  partner- 
ships.** Dividends  of  foreign  corporations  are  not 
taxable  in  the  hands  of  non-resident  aliens,  even  though 
the  dividends  may  be  payable  in  this  country.**  In 
two  provisions  of  the  1916  Law  **  non-resident  aliens 
are  excepted  from  the  requirements  to  make  reports 
of,  or  paj'  supertax  on,  "such  income  [income  derived 
from  dividends  on  the  capital  stock  or  from  the  net 
earnings  of  any  corporation]  derived  from  sources 
without  the  United  States."  The  language  quoted  has 
not  been  construed  by  the  courts  or  in  any  regulation 
of  the  Treasury  Department.  It  undoubtedly  applies 
to  dividends  received  from  foreign  corporations  where 
the  earnings  of  the  corporation  are  derived  from  sources 
without  the  United  States  even  though  the  dividends 

resident  alien  individuals.  See  Chapter  14  on  Foreign  Corpora- 
tions. 

11  See  Chapter  2  for  rate'". 

18  See  Chapter  23  for  further  discussion  of  this  subject. 

13T.  D.  2012,  T.  D.  2030,  T.  D.  2;n3,  T.  T).  2325.  Letter  from 
Treasury  Department  dated  April  5,  1916;  I.  T.  S.  1917,  ^  69. 
Exemption  is  claimed  from  withholding  of  the  tax  by  using  Form 
1071  (T.  D.  232.'))  or  by  using  Form  1063  (T.  D.  2012). 

14  §1  (b)  and  5  8  (f). 


46  FEDERAL    INCOME    TAX 

are  payable  in  this  country,  and  there  seems  to  be 
ground  for  the  contention  that  it  applies  with  equal 
force  whether  the  corporation  be  foreign  or  domestic.^^ 

Interest,  Non-resident  aliens  are  taxable  on  all  in- 
terest on  bonds,  notes  or  other  interest-bearing  obliga- 
tions of  residents  in  this  country  whether  the  debtor 
is  a  corporation,  partnership,  or  an  individual,  citizen 
or  alien.  Interest  received  from  a  non-resident  citizen 
is  not  taxable.  Whether  or  not  interest  received  from 
a  domestic  corporation  located  entirely  outside  of  this 
country  is  taxable  is  a  question  still  before  the  Treasury 
Department  for  determination.^®     The  extent  to  which 

15  Whether  Congress  intended  to  give  the  non-resident  alien  an 
exemption  from  tax  on  dividends  to  the  extent  that  such  dividends 
are  earned  by  domestic  corporations  outside  the  United  States,  is 
not  clear,  but  the  language  quoted  above  seems  open  to  a  broad 
construction.  The  English  law  recognizes  the  situation  where  a 
British  company  has  permanently  located  its  business  and  seat  of 
management  abroad,  and  taxes  it  only  with  respect  to  the  profits 
oi"  the  English  shareholders.  Eelatively  few  American  corporations 
are  formed  to  operate  entirely  outside  of  the  United  States,  but 
there  are  cases  where  not  only  does  the  corporation  operate  entirely 
abroad,  but  also  all  of  its  stockholders,  directors  and  creditors 
are  non-resident  aliens.  It  seems  reasonable  to  infer  in  the  absence 
of  express  language,  that  Congress  did  not  intend  the  tax  to  apply 
to  the  stockholders  of  such  corporations. 

16  This  point  involves  the  question  of  residence  of  the  corpora- 
tion. Generally  speaking,  under  the  laws  of  this  county  a  corpo- 
ration is  a  resident  of  the  state  in  which  it  is  incorporated  and 
cannot  migrate  to  another  jurisdiction.  If  however  the  word 
* '  residence ' '  is  given  its  ordinary  meaning,  a  domestic  corporation 
having  its  business  and  seat  of  management  permanently  located 
abroad  would  seem  to  be  a  "non-resident."  The  Treasury  De- 
partment has  defined  the  term  "non-resident  alien  corporation" 
with  respect  to  certain  requirements  of  the  law,  to  cover  all  corpo- 
rations authorized  or  existing  under  the  laws  of  a  foreign  country 
and   having  no  oflSee  or  place  of  business  in  the  United   States, 


NON-KESIDEKT    ALIEMS  47 

a  non-resident  alien  is  taxable  under  the  law  on  interest 
received  from  a  "resident  alien  corporation,"  that  is, 
a  foreign  corporation  having  a  branch  office  or  place 
of  business  in  this  country  has  not  been  decided.  If 
the  interest  is  paid  by  the  office  in  this  country  from 
funds  earned  here  it  may  be  taxable,  but  if  paid  from 
the  home  office  in  another  jurisdiction  it  does  not  seem 
that  it  would  be,  even  though  paid  out  of  funds  arising 
in  whole  or  in  part  from  sources  within  this  country, 
since  this  country  would  have  no  jurisdiction  over  the 
parties  or  the  income.  Interest  paid  by  non-residents — 
whether  citizens  or  aliens,  corporations  or  partnerships, 
or  by  foreign  governments, — is  not  taxable  by  reason 
of  the  fact  that  the  interest  may  be  paid  in  this  country. 
The  residence  of  the  debtor,  not  the  place  of  payment 
of  the  interest,  determines  its  taxability.  When  interest 
on  the  bonds  of  foreign  corporations  or  governments  is 
payable  in  this  country,  the  non-resident  alien  may  pre- 
vent withholding  at  the  source  by  filing  with  the  paying 
agent  a  certificate  prescribed  by  the  Treasury  Depart- 
ment for  that  purpose.*"' 

Interest  on  Bank  Deposits.  Where  banking  houses 
in  this  country,  carrying  deposits  for  non-resident  aliens, 
credit  such  accounts  with  interest  thereon,  such  interest 
must  be  included  in  the  recipient's  income  tax  return 
for  the  year  during  which  he  received  the  interest,  or 
in  which  it  was  credited  to  an  account  against  which 

T.  D.  2401,  but  has  made  no  definition  with  respect  to  residence  of 
domestic  corporations. 

17  T.  D.  2325.  The  official  title  of  this  form  is  Form  1071.  It 
was  drafted  ori^nnally  for  the  use  of  hanks  acting  as  agents,  but 
may  be  modified  to  show  personal  ownership  and,  thus  modified, 
may  be  executed  by  the  non-resident  alien  himself.  Letter  from 
Treasury  Department  dated  June  13, 1916;  I.  T.  S.  1917, 1 122. 


48  FEDERAL   INCOME  TAX 

he  might  draw.  The  bank,  however,  is  not  required  to 
withhold  the  tax  on  such  interest  or  to  make  any  return 
covering  the  amount  of  interest  paid  to  any  depositor.^* 

Salaries  Paid  by  Resident  Employers.  Under  the 
1913  Law  it  was  held  that  compensation  paid  to  non- 
resident aliens  for  services  rendered  in  a  foreign  coun- 
try, including  business  and  travel  expenses,  was  not 
taxable.^®  The  1916  Law,  by  imposing  a  tax  on  "income 
from  all  sources  within  the  United  States,"  raises  a 
question  as  to  the  taxability  of  such  compensation,  a 
question  which  is  still  before  the  Treasury  Department 
for  decision.'*® 

Income  Received  prom  Trustees,  Executors  or 
Other  Fiduciaries.  Where  a  non-resident  alien  is  the 
beneficiary  of  a  trust,  or  of  the  estate  of  a  deceased 
person,  or  is  the  recipient  of  income  from  any  property 
held  by  another,  such  income  is  taxable  to  the  extent 
that  it  arises  from  sources  within  the  United  States. 
The  intervention  of  an  agent,  trustee  or  other  fiduciary 
between  the  non-resident  alien  and  the  source  of  the 
income  does  not  make  income  subject  to  taxation,  which 

18  Letter  from  Treasury  Department  dated  June  29,  1917;  I. 
T.  S.  1917,  U  2256. 

19  T.  D.  2152. 

20  The  Treasury  Department  has  indicated  an  intention  to  hold 
the  non-resident  alien,  to  be  not  taxable  if  the  employer  derives 
all  his  income  from  the  foreign  jurisdiction,  but  to  hold  him  tax- 
able if  the  major  or  principal  part  of  the  business  is  carried  on 
in  this  country  and  the  non-resident  alien  is  employed  in  foreis^i 
jurisdictions  as  incident  to  the  main  business  in  this  country.  This 
distinction  is  artificial  and  will  lead  to  many  diflSculties.  A  fair 
rule  would  seem  to  be  to  hold  that  the  source  of  the  income  of 
non-resident  alien  employees  is  in  the  country  where  the  services 
are  performed  even  though  payment  is  made  from  this  country. 


NON-RESIDENT   .VMENS  49 

otherwise  would  not  be  taxable,  nor  does  it  serve  to 
relieve  from  taxation  income  which  otherwise  would 
be  taxed.*^  Dividends,  for  instance,  would  not  be  sub- 
ject to  the  normal  tax  for  the  reason  that  they  are  paid 
to  a  trustee  and  by  him  distributed  to  non-resident 
aliens.**  Similarly,  exempt  income  is  not  made  tax- 
able by  passing  through  the  hands  of  a  fiduciary  to 
the  beneficiary.**  One  important  class  of  exempt  income 
from  estates  is  gifts,  legacies,  bequests,  etc.,  the  prin- 
cipal sum  being  exempt,  but  the  income  therefrom  being 
taxable.**  Where  a  non-resident  alien  is  a  trustee,  or 
other  fiduciary,  of  an  estate  deriving  income  from 
sources  within  the  United  States,  he  is  charged  with 
the  duty  of  making  a  return  of  such  income,  and  the 
normal  tax  is  withheld  at  the  source  on  payments  of 
fixed  and  determinable  income  made  to  him  by  persons 
in  this  country.** 

Income  from  Partnerships.  Non-resident  aliens,  who 
are  members  of  partnerships  deriving  all  their  income 
from  sources  within  this  country,  are  taxable  on  their 
entire  distributive  shares,**  If  a  partnership  derives 
only  part  of  its  income  from  sources  within  the  United 
States,  non-resident  alien  partners  are  taxable  only  on 
that  part  of  their  respective  shares  of  the  profits  which 

81  Letter  from  Treasury  Department  dated  March  25,  1915; 
I.  T.  S.  1917;  1I1[89  and  90. 

22  Letter  from  Treasury  Department  dated  April  5,  1916;  I. 
T.  S.  1917, 1[  42. 

23  Exempt  income  is  not  reported  by  the  fiduciary,  as  income 
nccruing  to  the  estate,  for  the  purpose  of  the  tax. 

24  See  Chapter  25. 

25  Letter  from  Treasury  Department  dated  December  28,  1916; 
I.  T.  S.  1917,  1 1963.    See  Chapter  9. 

26  See  Chapter  10  on  partnerahipg. 

P.  I.  Tax.— 4 


50  FEDERAL.   INCOME   TAX 

represent  income  of  the  partnership  from  such  sources.*' 
This  would  seem  to  be  true  although  the  partnership  had 
its  principal  place  of  business  here  from  which  the  opera- 
tions abroad  were  directed. 

Profits  on  the  Sale  of  Property.  Non-resident 
aliens  are  taxable  on  profits  and  gains  from  the  sale  of 
real  or  personal  property  located  in  the  United  States.*^ 
Where  sales  of  intangible  personal  property,  for  example, 
stocks,  bonds,  notes,  etc.,  of  domestic  corporations  or 
residents  are  made  in  the  United  States,  the  profit  is 
held  to  be  taxable  and  the  custodian  of  the  securities 
here  is  charged  with  the  duty  of  reporting  the  profit  of 
the  non-resident  alien,  for  which  purpose  he  must  place 
himself  in  possession  of  all  the  facts  necessary  to  an  ac- 
curate determination  of  the  amount  of  profit  or  loss  in 
the  transaction.29  If  a  sale  of  such  intangible  personal 
property  is  made  in  a  foreign  country  by  a  non-resident 
alien,  it  does  not  seem  that  the  seller  would  be  taxable 
on  the  gain  or  profit  therefrom. 

Other  Income.  Gains  or  profits  and  income  derived 
from  any  source  whatever  in  the  United  States  (except 
exempt  income)  are  taxable.^®    The  questions  whjch  arise 

87  This  is  one  of  the  many  questions  on  which  the  Treasury  De- 
partment has  not  as  yet  made  any  public  statement  of  its  position. 
The  status  of  a  partner  differs  from  that  of  a  stockholder  in  a 
corporation  since  in  the  case  of  a  partnership  there  is  no  separate 
entity  interposed  between  the  recipient  of  the  income  and  its 
original  source. 

28  See  Chapter  20  for  method  of  computing  taxable  gains  on  the 
sf;le  of  property. 

29  Letter  from  Treasury  Department  dated  May  31,  1916;  I. 
T.  S.  1917,  H  86. 

30  Act  of  September  8,  1916,  §  1,  §  2  and  §  4. 


NON-RESIDENT    AUENS  51 

in  this  coimeetion  are  with  respect  to  the  source  of  the 
income,  rather  than  with  respect  to  its  character.  Alany 
of  the  questions  will  be  settled  only  by  the  slow  and 
gradual  process  of  development  of  the  law,  through  liti- 
gation and  by  specific  rulings  of  the  Treasury  Depart- 
ment on  cases  brought  to  its  attention.** 

Deductions  Allowed  in  Computing  Net  Income.  A 
non-resident  alien  is  required  to  report  all  his  taxable 
income  from  sources  within  this  country,  but  from  the 
gross  amount  so  reported  is  entitled  to  make  certain  de- 
ductions before  the  tax  is  assessed  on  the  remainder. 
The  deductions  are  similar  in  kind  to  those  allowed  to 
residents  and  citizens  but,  in  general,  are  confined  to 
expenditures  made  with  respect  to  the  income  subject  to 
tax  or  limited  by  the  proportion  of  the  individual's  in- 
come derived  from  sources  within  this  country.  An  ex- 
tended discussion  on  deductions  is  contained  in  other 
chapters,  the  discussion  in  this  chapter  being  limited  to 
the  provisions  which  apply  particularly  to  non-resident 
aliens.** 

Expenses.  All  necessary  expenses  actually  paid  in 
carrying  on  any  business  or  trade  conducted  within  the 
United  States  may  be  deducted,  but  not  including  per- 

81  This  development  of  the  law  may  be  hastened  by  action  of 
Congress  in  making  amendments  more  clearly  defining  taxable 
sources.  At  present  there  is  not  only  uncertainty  as  to  the  mean- 
ing of  the  law  as  it  stands,  but  also  a  need  for  amendment.  The 
phrase  "sources  within  the  United  States"  is  too  broad  and  in- 
definite for  practical  certainty  and  it  naturally  results  in  imposing 
the  tax  on  incomes  in  cases  where  there  is  serious  question  as  to 
the  moral  right  or  economic  wisdom  of  so  doing. 

38  The  deductions  allowed  to  a  non-resident  alien  are  set  forth 
at  length  in  the  1916  Law,  §  6. 


52  FEDERAL   INCOME   T.VX 

soual  living  or  family  expenses.  Where  the  business 
or  trade  carried  on  in  this  country  is  by  means  of 
separate  and  distinct  branches  the  expenses  are  readily 
determined.  Where  the  accounts  are  kept  at,  and  the 
business  is  under  the  supervision  of,  the  home  office 
abroad,  the  home  office  expenses  connected  therewith, 
if  segregated,  may  be  included.  If  not  segregated,  the 
Treasury  Department  has  permitted  the  deduction  of 
such  proportion  of  the  entire  expenses  of  the  business 
as  the  gross  income  from  this  country  bears  to  the  entire 
gross  income  from  business  done  both  within  and  with- 
out the  United  States.'^ 

Interest.  The  proportion  of  all  interest  paid  within 
the  year  by  a  non-resident  alien  on  his  indebtedness, 
(except  on  indebtedness  incurred  for  the  purchase  of 
obligations  or  securities  the  interest  upon  which  is 
exempt  from  taxation  as  tncome  under  the  1916  Law) 
which  the  gross  amount  of  his  income  for  the  year 
derived  from  sources  within  the  United  States  bears  to 
the  gross  amount  of  his  income  for  the  year  derived 
from  all  sources  within  and  without  the  United  States 
may  be  deducted.  For  instance,  if  half  of  the  indi- 
vidual 's  gross  income  for  the  year  is  from  sources  within 
the  United  States,  he  may  deduct  one-half  of  the  entire 
amount  of  interest  he  has  paid  during  the  year  on  his 
indebtedness.  To  obtain  this  deduction  it  is  required 
that  the  claimant  report  the  entire  amount  of  interest 
paid  during  the  year  and  his  entire  gross  income  from 
all  sources,  so  that  the  Treasury  Department  may  cal- 
culate the  amount  of  deduction  to  which  he  is  entitled.^* 

33  See  Cliapter  28  for  general  discussion  of  deduction  of  busi- 
ness expenses. 

84  See  Chapter  29  on  deduction  of  interest. 


NON-RESIDENT   ,\UEa«:S  53 

Taxes.  Subject  to  the  limitations  applicable  to  all 
classes  of  taxpayers,  the  non-resident  alien  may  deduct 
all  taxes  imposed  by  the  authority  of  the  United  States 
or  its  territories,  or  possessions,  or  under  the  authority 
of  any  State,  county,  city,  school  district,  and  other 
taxing  subdivision  of  any  State,  and  paid  within  the 
United  States,  The  general  limitations  are  discussed  in 
a  subsequent  chapter.'* 

Losses  Incurred  in  Tr.vde.  Losses  incurred  in  the 
non-resident  alien's  business  or  trade  may  be  deducted, 
if  actually  sustained  during  the  year  and  incurred  in 
business  or  trade  conducted  within  the  United  States. 
Losses  of  property  within  the  United  States  arising  from 
fires,  storms,  shipwreck  or  other  casualty,  and  from  theft, 
may  also  be  deducted  to  the  extent  that  such  losses  are 
not  compensated  for  by  insurance  or  otherwise.'® 

Loss  Not  Incurred  in  Trade.  In  the  case  of  losses 
in  transactions  entered  into  for  profit  but  not  connected 
with  his  business  or  trade,  the  losses  actually  sustained 
during  the  year  may  be  deducted  to  an  amount  not  ex- 
ceeding the  profits  arising  therefrom  in  the  United  States. 
The  profits  arising  from  such  transactions  must  be  re- 
ported as  income,  and  the  losses  sustained  therein  may 
be  deducted,  to  an  amount  not  exceeding  the  income  so 
reported.  It  seems  that  the  tax  is  imposed  on  the  net 
profits  of  the  year  on  a  series  of  such  transactions  taking 
place  in  this  country,  the  loss  in  one  transaction  being 
set  off  against  the  gain  in  another.  But  if  the  entire 
series  of  transactions  results  in  a  loss,  that  loss  may  not 
be  set  off  against  income  from  busines  or  trade  in  this 

35  See  Chapter  30  on  deduction  of  taxes. 

36  See  Chapter  31  for  general  discussion  of  losses. 


54  FEDERAL   INCOME   TAX 

country.    What  constitutes  losses  not  incurred  in  trade 
is  explained  in  another  chapter.^'' 

Bad  Debts.  Debts,  arising  in  the  course  of  business 
or  trade  conducted  by  him  within  the  United  States, 
due  to  the  taxpayer,  actually  ascertained  to  be  worthless 
and  charged  off  within  the  year,  may  be  deducted.^^ 

Depreciation.  A  reasonable  allowance  for  the  ex- 
haustion, wear  and  tear  of  property  within  the  United 
States,  arising  out  of  its  use  or  employment,  is  granted 
under  the  same  rules  and  regulations  as  apply  to  resi- 
dents.*® 

Depletion  of  Natural  Resources.  A  reasonable 
allowance  is  permitted  for  the  depletion  of  oil  and 
mineral  deposits,  if  the  property  is  within  the  United 
States.  This  depletion  allowance  is  granted  under  cer- 
tain rules  and  restrictions  more  fully  discussed  in  the 
chapters  dealing  with  that  subject.*** 

Dividends..  Taxable  dividends  received  from;  this 
country  must  be  reported.  They  are  excluded  from  the 
net  income  for  the  purpose  of  computing  the  normal  tax, 
but  included  for  the  purpose  of  computing  the  super- 
taxes. 

Tax  Withheld  at  the  Source.  As  the  law  requires 
the  normal  tax  to  be  withheld  by  the  one  in  this  country 

37  See  Chapter  4  for  definition  of  losses  not  incurred  in  trade. 

38  See  Chapter  31  for  general  discussion  of  deduction  of  bad 
debts. 

39  See  Chapter  32  on  depreciation. 

40  See  Chapter  33  and  Chapter  34  on  depletion. 


NON-RESIDENT    ALiIBNS  55 

who  pays  fixed  or  determinable  income  to  a  non-resident 
alien,**  a  due  credit  for  the  amount  so  withheld  is  allowed 
to  be  claimed  in  filing  the  annual  return.  The  non- 
resident alien  should  therefore  keep  a  record  of  the 
amount  of  tax  withheld  at  the  source  from  time  to  time 
on  payments  made  to  him,  and  should  report  the  aggre- 
gate sum  so  withheld  in  his  annual  return,  in  order 
that  the  normal  tax  may  not  be  twice  collected  with 
respect  to  the  same  income. 

Personal  Exemption.  Under  the  1916  Law,  non- 
resident aliens  were  entitled  to  claim  the  same  amount 
of  personal  exemption  as  residents  or  citizens,  provided 
they  filed  the  annual  return,  but  by  the  amendment  of 
October,  1917,  this  privilege  was  revoked.**  The  tax  is 
now  assessed  upon  all  of  the  non-resident  alien's  net 
income  from  sources  within  this  country. 

Return  of  Annual  Net  Income.  A  non-resident  alien, 
either  personally  or  through  his  agents  in  this  country, 
is  required  to  file  a  return  of  annual  net  income  on  or 
before  March  1  in  each  year,  if  his  net  income  from 
sources  within  the  United  States  is  $1*000  or  over  during 
the  year.**     He  may  file  the  return,  although  his  net 

41  See  Chapter  41  on  collection  at  the  source. 

48  The  privilege  did  not  exist  under  the  1913  Law,  as  construed 
by  the  Treasury  Department,  so  permission  to  claim  the  personal 
exemption  was  extended  to  non-resident  aliens  only  in  the  year  1916. 

43  The  law  is  obscure  on  this  point.  The  1916  Law,  5  8  (b),  re- 
quires a  return  by  every  person  having  a  net  income  of  $3,000  or 
over  for  the  taxable  year;  the  1917  Law,  §3,  requires  a  return 
from  unmarrie<l  persons  if  the  net  income  is  $1,000  or  over,  and 
from  married  persons  if  the  net  income  is  $2,000  or  over.  These 
amounts  are  predicated'  on  the  personal  exemption  allowed  to  un- 
married and  married  persons,  respectively,  an  exemption  to  which 


56  FEDERAL   INCOME  TAX 

income  is  less  than  $1,000,  if  he  desires  to  claim  the 
deductions  and  credits  allowed  him  under  the  law.** 
Thus,  a  non-resident  alien  may  have  had  the  tax  on  all 
his  income  from  this  country  withheld  at  the  source, 
although  he  may  be  taxable  on  a  lesser  Timount  by  rea- 
son of  deductions  for  expenses,  interest,  losses,  etc.  Only 
by  filing  a  return  may  he  claim  those  deductions,  and 
upon  so  doing,  the  amount  withheld,  in  excess  of  his 
tax  liability,  will  be  returned  to  him.  For  the  purpose 
of  obtaining  such  refund,  he  should  attach  to  his  return 
a  statement  giving  the  names  and  post-oflSce  addresses 
of  all  persons,  firms  or  corporations  who  have  withheld 
the  tax  on  income  paid  to  him  during  the  year,  and  the 
amount  of  tax  withheld  by  each  respectively.  The  Trea- 
sury Department  will  thereupon  order  the  withholding 
agents  to  release  the  excess  withheld.**  Non-resident 
aliens  are  entitled  to  extensions  of  time  for  filing  returns, 
and  are  subject  to  penalties  for  failure  to  file  returns, 
under  the  same  provisions  of  law  as  apply  to  citizens.*® 
In  case  a  non-resident  alien  fails  to  file  a  return,  the 

non-resident  aliens  are  not  entitled.  However,  it  seems  clear  that 
the  law  does  not  require  a  return  of  individuals  in  any  case  where 
the  income  for  the  year  is  less  than  $1,000,  and  it  would  seem 
that  Congress  did  not  intend  to  allow  a  married  non-resident  alien 
any  greater  exemption  because  of  his  married  status. 

44  The  same  form  (Form  1040)  is  prescribed  for  use  of  all  in- 
dividuals, residents  and  non-residents.  A  non-resident  alien  pre- 
paring the  return  on  this  form  should  bear  in  mind  that  it  covers 
in  his  case  only  income  from  sources  in  this  country,  and  make 
such  changes  as  are  necessary  to  indicate  that  fact.  The  additional 
iaiformation  required  in  order  to  compute  the  amount  of  deductible 
interest  should  be  made  on  a  supplementary  statement  attached  to 
the  return. 

46  Telegram  from  Treasury  Department  dated  January  25,  1917; 
I.  T.  S.  1917,  H  1997. 

46  See  Chapter  35  and  Chapter  37. 


NON-RESIDENT   ALIENS  57 

collector  may  assess  the  tax  on  information  from  other 
sources,  and  all  property  of  such  alien  in  this  country 
will  be  liable  to  distraint  for  the  tax,*''  The  return  is 
filed  in  the  district  in  which  the  non-resident  alien  has 
his  principal  place  of  business  in  this  country,  or  if  he 
lias  none,  then  with  the  Collector  of  Internal  Revenue  at 
Baltimore,  Maryland.  If  the  return  is  filed  by  an  agent 
in  this  country,  the  place  of  filing  may  be  either  the 
district  in  which  the  agent  resides  or  the  district  in  which 
he  has  his  principal  place  of  business.  It  should  be 
borne  in  mind  that  a  non-resident  alien  may  have  an 
agent  in  this  country,  for  the  purpose  of  the  income 
tax,  without  having  appointed  one.  The  fact  that  $1,000 
or  more  of  income  of  a  non-resident  alien  is  in  the 
custody  or  control  of  a  resident  of  this  country,  makes 
that  resident  an  agent,  charged  with  the  duty  of  making 
an  annual  return  and  collecting  the  tax.  A  non-resident 
alien  may,  therefore,  have  several  agents  in  this  coun- 
try, each  responsible  for  the  income  passing  through 
his  hands.  To  avoid  having  a  return  filed  by  each,  the 
non-resident  alien  may  make  one  return  covering  all  of 
his  income,  or  designate  one  of  the  agents  to  make  such 
return,  in  which  case  he  must  inform  the  agent  so 
designated  of  all  his  taxable  income  from  sources  within 
this  country.  The  other  agents  should  also  be  notified 
of  the  action  taken  and  instructed  not  to  file  returns. 
The  duties  and  responsibilities  of  such  agents  are  more 
fully  discussed  in  a  subsequent  chapter.** 

Pajring  the  Tax.    The  tax  is  due  on  June  15  following 
the  filing  of  the  annual  return,  and  penalties  accrue  if 

47  Act  of  September  8,  1916,  §6  (c),  as  amended  by  Act  of 
October  3,  1917. 

48  See  Chapter  6  on  Resident  Agents. 


58  FEDERAL   INCOME   TAX 

it  is  not  paid  within  ten  days  after  notice  and  demand 
therefor.*^  If  the  return  is  not  filed  on  time,  the  tax  is 
due  immediately  upon  assessment,  and  penalties  accrue 
if  not  paid  within  ten  days  after  notice  and  demand. 
Penalty  and  interest  for  delay  in  payment  are  added, 
as  in  the  case  of  delinquent  residents  or  citizens.^"  As 
to  the  form  in  which  to  make  payment  see  the  chapter  on 
assessment  and  payment  of  the  tax.^^ 

Abatement  and  Refund  of  the  Tax.  If  upon  the 
filing  of  the  annual  return,  it  appears  that  the  non- 
resident alien  is  liable  for  less  tax  than  the  amount  which 
has  been  withheld  at  the  source,  the  Treasury  Depart- 
ment will  issue  instructions  to  the  withholding  agents 
(whose  names  and  addresses  should  be  given  by  the  non- 
resident alien  on  his  return)  to  release  at  once  the  proper 
amounts.*^  After  the  tax  has  been  assessed  against  the 
withholding  agents  by  the  Government,  abatement  may 
be  claimed,  and  after  the  tax  has  been  paid,  refund  may 
be  claimed,  in  the  manner  outlined  in  a  later  chapter.^^ 

49  See  Chapter  36. 

60  Id. 

61  Id. 

62  Telegram  from  Treasury  Department  dated  January  25,  1917; 
I.  T.  S.  1917,  H  1997. 

63  See  Chapter  39  on  Abatement  and  Kefund. 


CHAPTER  6 

RESIDENT  AGENTS  FOB  NON-RESIDENT  ALffiNS,  FOREIGN  COR- 
PORATIONS AND  FOREIGN  PARTNERSHIPS 

As  set  forth  in  another  chapter  ^  the  law  expressly 
provides  for  the  collection  at  the  source  of  the  tax  on 
payment  of  certain  specified  forms  of  income  to  non- 
resident aliens  and  non-resident  foreign  corporations. 
The  persons  required  to  withhold  and  account  for  the 
tax  are  designated  in  the  regulations  as  withholding 
agents.  The  Treasury  Department  has,  in  addition, 
evolved  a  method  of  collecting  the  tax  on  income  which 
may  pass  out  of  its  jurisdiction,  by  impressing  upon 
residents,  under  certain  circumstances,  the  duty  of  filing 
returns  and  accounting  for  the  normal  tax  and  the  super- 
tax on  any  and  all  income  of  non-resident  aliens  and  non- 
resident foreign  corporations  over  which  they  have  cus- 
tody or  control.*  Such  persons  are  held  to  be  agents  of 
the  non-residents  and  to  stand  in  the  place  of  their  prin- 
cipals.' One  who  is  a  withholding  agent  under  the  pro- 
visions for  collecting  the  tax  at  the  source  may,  or  may 
not,  (depending  on  the  circumstances)  also  be  an  agent 
within  the  meaning  of  this  chapter.    Agents  for  foreign 

1  See  Chapter  41  on  collection  at  the  source. 

8  The  Department  evidently  bases  its  authority  for  this  on  §  9 
(g),  of  the  1916  Law  which  provides  that  the  tax  shall  be  paid 
by  the  owner  of  the  income  "or  the  proper  representative  having 
the  receipt,  custody,  control  or  disposal  of  the  same. "    T.  D.  2452. 

3T.  T).  21.15. 

5U 


60  FEDERAL   INCOME   TAX 

partnerships  are  not  required  to  make  any  returns  or  pay- 
any  tax  for  the  foreign  partnership  unless  and  until  they 
are  so  instructed  by  the  Commissioner  of  Internal  Reve- 
nue.* 

Definition.  In  order  to  simplify  the  discussion  in  the 
following  pages  of  this  chapter  the  term  '  *  non-residents ' ' 
will  be  used  to  include  non-resident  aliens,  foreign  cor- 
porations having  no  office  or  place  of  business  in  this 
country,  and  foreign  partnerships  having  no  office  or 
place  of  business  in  this  country .*• 

Who  are  Resident  Agents.  A  resident  corporation, 
partnership  or  individual,  may  be  an  agent  within  the 
meaning  of  this  chapter.  Any  residents  acting  by  power 
of  attorney  for  non-residents  are  such  agents.  Re- 
sponsible heads  or  representatives  who  are  in  charge  of 
property  owned  or  business  carried  on  by  non-residents 
in  this  country  are  such  agents.®  Resident  nominal 
stockholders  who  hold  stock  in  their  names  for  non-resi- 
dent actual  owners  are  such  agents.''^  Residents  having 
custody  of  securities  of  non-residents,  on  which  they 
collect  the  income,  are  agents  not  only  with  respect  to 
the  income,  but  also  with  respect  to  any  profits  made 
from  the  sale  of  the  securities  of  which  they  are  cus- 
todians, and  for  the  purpose  of  reporting  the  latter  they 
are  required  to  obtain  all  facts  necessary  to  ascertain 

4  T.  D.  2401,  This  is  because  a  partnership  is  not  itself  subject 
to  a  tax  or  required  to  make  returns.  See  Chapter  11  on  foreign 
partnerships. 

6  For  definition  of  ' '  foreign  corporations ' '  as  used  in  this  book 
see  Chapter  14.  For  definition  of  foreign  partnership  as  used  in 
this  book  see  Chapter  11, 

6  Reg.  33,  Art.  8;  T.  D.  2313. 

7  See  Chapter  7  on  nominal  stockholders. 


RESIDENT  AGENTS  FOR  NON-RESIDENT   ALIENS  61 

the  profit  in  any  transaction.*  Residents,  purchasing 
patent  rights  from  non-residents  and  paying  royalty 
thereon,  are  held  to  be  agents.®  Real-estate  agents  who 
manage  buildings  owned  by  non-residents  are  such 
agents.*® 

Who  are  Not  Such  Agents.  Corporations  paying  in- 
terest on  their  own  bonds,  or  dividends  on  their  own 
stock,  to  non-residents,  bondholders  or  stockholders,  are 
not  held  to  be  agents  within  the  meaning  of  this  chapter, 
although  they  are  withholding  agents  for  the  purpose 
of  collection  at  the  source.  Resident  debtors,  individual 
or  partnership,  are  not  held  to  be  agents,  but  are  required 
to  withhold  to  tax  at  the  source  on  interest  paid  to  non- 
resident aliens.  Banks  are  not  agents  for  their  non- 
resident depositors,  where  the  relation  is  merely  that  of 
bank  and  depositor  **  and  the  same  has  been  held  where 
a  bank  received  interest  and  dividends  direct  from 
domestic  corporations  to  be  credited  to  the  accounts  of 
non-resident  depositors.**  A  bank  holding,  for  account 
of  foreign  banks  and  bankers,  securities  on  which  it 
collects  interest  and  disburses  the  same  to  the  foreign 
banks  and  bankers,  has  not  been  held  to  be  an  agent," 
but  where  a  bank  acts  as  custodian  of  securities  for  non- 

S  Letter  from   Treasury  Department   dated   May  31,   1916;   I. 
T.  S.  1917,  1  86. 
8T.  D.  2137. 

10  Letter  from  Treasury  Department  dated  January  19,  1915; 
I.  T,  S.  1917,  1  80. 

11  Banks  are  not  held  to  be  withholding  agents  with  respect  to 
interest  paid  on  deposits.    Reg.  33,  Art.  67. 

18  Letter  from  Treasury  Department  dated  February  8,  1917; 
I  T.  S.  1917,  f  2003. 

18  Letter  from  Treasury  Department  dated  April  10,  1916;  I. 
T.  8.  1917,  H  120. 


d2  t'iiDfiKAL,    IJ^CUME   TAA 

residents  other  than  banks,  the  rule  seems  to  be  that  it 
is  an  agent.  ^* 

Duties  and  Liabilities  of  Resident  Agents.  The  duty 
of  a  resident  agent  for  a  non-resident  alien  individual 
or  non-resident  foreign  corporation  is  to  account  for  all 
income  passing  through  his  hands,  in  an  annual  return 
to  the  local  collector,  and  to  pay  all  taxes  assessed 
thereon.^**  He  is  under  no  duty  to  inquire  into  or  report 
any  income  of  the  non-resident  principal  received  from 
other  sources  in  this  country,  but  may,  if  authorized  by 
the  non-resident  principal,  make  a  complete  return  of 
all  income  from  this  country.  Where  the  same  non- 
resident has  several  agents,  none  of  whom  is  authorized 
and  enabled  to  make  a  return  of  all  the  principal's  in- 
come, each  agent  reports  separately  the  income  coming 
into  his  hands,  and  the  Treasury  Department  takes  into 
consideration  the  aggregate  amount  of  net  income, 
covered  by  all  of  the  returns,  in  assessing  the  tax,  giving 
credit  for  the  amount  assessed  on  each  return,  and  mak- 
ing a  further  assessment  to  cover  the  supertax  which 
may  be  due  on  the  aggregate  income  in  the  case  of  in- 
dividuals.^* Of  course,  if  the  non-resident  principal  files 
a  return  of  all  his  income  from  sources  within  this 
country,  the  agents  are  not  also  required  to  file  returns. 
Resident  agents  should,  therefore,  ascertain  in  due  time 

14  The  rulings  are  not  clear  or  consistent  on  this  point,  but  it 
seems  that  the  rulings  bear  out  the  conclusions  in  the  text. 

14a  It  is  uncertain  under  the  language  of  the  1917  Law  whether 
or  not  a  resident  agent  can  be  required  to  file  a  return  for  a  non- 
resident principal  if  the  amount  of  income  in  his  custody  is  less 
than  $1,000  during  any  year.  A  ruling  on  this  point  will  be 
necessary. 

16  Letter  from  Treasury  Department  dated  March  6,  1917;  I. 
T.  S.  1917,  1(2112. 


KESIDEINT   AGENTS  FOR   NON-RESIDENT   ALIENS  63 

what  their  non-resident  principals  intend  to  do  as  to  re- 
porting and  paying  the  tax,  and  govern  themselves  ac- 
cordingly. 

Procedure  in  Collecting  Income  for  Non-Residents. 
In  collecting  income  subject  to  withholding  of  the  tax 
at  the  source,  the  resident  agent  should  execute  the  own- 
ership certificate  required  of  his  non-resident  principal, 
signing  it  with  the  name  of  the  principal  and  afl&xing 
his  own  signature  as  agent.^*  In  brief,  with  respect  to 
such  income,  he  should  proceed  as  is  required  of  the  non- 
resident principal,  in  whose  place  he  stands  for  the  pur- 
pose of  the  income  tax.  The  fact  that  the  non-resident 
lias  an  agent  here  does  not  relieve  his  income  from  with- 
holding at  the  source  when  paid  to  such  agent. 

Making  Returns  for  Non-Resident  Principal.  In 
making  the  annual  return  for  his  non-resident  principal 
the  resident  agent  should  use  the  same  form  as  would 
be  used  by  the  principal^''  and  follow  the  provisions  of 
the  law  and  the  regulations  relating  to  non-resident 
aliens  or  foreign  corporations,  as  the  case  may  be,  in 
claiming  deductions.  At  present  the  same  forms  are 
used  for  residents  and  non-residents  alike,  and,  when 
used  by  or  for  a  non-resident  alien,  require  certain 
changes  in  wording,  such  as  a  statement  at  the  beginning 
that  the  return  covers  only  income  from  sources  within 
the  United  States.  In  the  affidavit  at  the  end  of  the 
individual's  form,  to  be  executed  by  the  agent,  a  state- 
ment should  be  made  that  the  return  covers  only  the 

16  See  Chapter  41  on  collection  at  the  source. 

IT  Form  1040,  in  the  case  of  individuals;  Form  1030  or  1030 A, 
in  the  case  of  insurance  companies,  and  Form  1031,  in  the  case 
of  other  corporations. 


64  PEDEKALi  INCOME  TAX 

income  received  by  the  agent,  or  that  it  covers  all  of 
the  income  of  the  principal  from  sources  within  the 
United  States,  as  the  case  may  be.  The  affidavit  on  the 
corporation's  form  is  prepared  for  execution  by  two  offi- 
cers of  the  corporation.  When  the  return  is  signed  by 
an  agent  for  a  foreign  corporation,  an  affidavit  that  he 
is  the  properly  authorized  agent,  and  that  the  report 
covers  income  from  all  sources  within  the  United  States, 
or  income  passing  through  his  hands,  as  the  case  may 
be,  should  be  attached  to  the  return  and  duly  executed. 
The  return  may  be  filed  in  the  district  in  which  the 
agent  resides  or  has  his  principal  place  of  business. 

Paying-  the  Tax  for  Non-Resident  Principal.  After 
filing  the  return,  the  agent  will  in  due  course  receive  a 
notice  of  assessment  showing  the  amount  of  tax  assessed 
on  the  income  reported.^*  The  tax  becomes  due  and  pay- 
able at  the  same  time  and  in  the  same  manner  as  the 
tax  assessed  on  the  income  of  a  resident,  and  may  be 
paid  in  the  same  way.^®  Upon  paying  the  tax,  the  agent 
may  demand  a  separate  receipt  for  the  amount  paid  on 
behalf  of  his  non-resident  principal,  and  such  receipt  is 
sufficient  evidence  to  justify  the  agent  in  withholding 
the  amount  therein  expressed  from  his  next  payment  to 
the  principal,  if  he  has  not  already  withheld  a  sufficient 

18  A  special  ruling  was  made  to  cover  cases  in  1916,  where  the 
agent  for  a  non-resident  alien  had  received  income  from  corporate 
interest  or  dividends  and  paid  the  same  over  to  his  principal  prior 
to  September  8.  In  such  cases,  if  the  agent  did  not  have,  between 
September  8  and  the  end  of  the  year,  any  income  of  the  non- 
resident alien  from  which  to  pay  the  tax  he  was  relieved  from 
liability,  leaving  the  tax  a  charge  against  the  non-resident  alien 
to  be  collected  direct  from  him  by  the  Treasury  Department.  T.  D. 
2402. 

19  See  Chapter  36  on  assessment  and  payment  of  the  tax. 


RESIDENT   AGENTS   FOB   NON-RESIDENT    ALIENS  65 

amount  to  satisfy  the  tax.  The  principal  may  demand 
this  receipt  from  the  agent  upon  giving  him  a  full  writ- 
ten receipt  acknowledging  the  payment  of  the  tax  as  a 
satisfaction  of  the  agent's  debt  to  that  extent.*® 

Abatement  and  Refund.  Taxes  improperly  or  ille- 
gally assessed  or  collected  may  be  abated  or  refunded 
in  the  manner  indicated  in  the  chapter  dealing  with  that 
subject.** 

20  Act  of  September  8,  1916,  §  17. 

21  See  Chapter  39  on  refund  and  abatement. 


P.  l.  Tax.— f} 


CHAPTER  7 

NOMINAL  STOCKHOLDERS 

For  convenience  in  handling  financial  transactions, 
stock  certificates  are  sometimes  issued  in  the  names  of 
persons  other  than  the  actual  owners  of  the  stock.  The 
persons  so  holding  the  nominal  title  to  the  stock  are 
known  as  nominal  stockholders,  or  stockholders  of  rec- 
ord, and,  of  course,  are  agents  for  the  actual  owners 
within  the  meaning  used  in  the  preceding  chapter,  when 
the  actual  owners  are  non-resident  aliens  or  non-resident 
foreign  corporations.  Nominal  stockholders,  acting  by. 
arrangement  between  the  parties,  are,  of  course,  aware 
of  the  name  and  status  of  the  actual  owner,  but  in  some 
cases  one  may  become  a  nominal  stockholder  without  any 
knowledge  of  who  the  actual  owner  is.  Thus,  stock  cer- 
tificates, endorsed  in  blank  by  an  actual  owner  and  sold 
on  the  market,  may  pass  by  delivery  to  several  consecu- 
tive purchasers  before  the  stock  is  transferred  on  the 
books  of  the  corporation.  In  such  eases,  the  original 
transferor  remains  the  record  owner  until  the  transfer 
is  made  on  the  corporate  books,  and,  as  such,  is  presumed 
to  be  the  real  owner  of  the  dividends  declared  on  the 
stock,  unless  he  proves  that  actual  ownership  of  the  stock 
does  not  rest  in  him.  If,  however,  the  record  owner  has 
not  only  parted  with  his  certificate  endorsed  in  blank, 
but  has  also  given  the  corporation  a  "dividend  order" 
to  pay  the  dividends  to  another,  his  responsibility  for 
the  tax  on  such  dividends  ceases,  and  the  one  to  whom 

66 


NOMINAL  STOCKHOLDERS  67 

the  corporation  pays  the  dividends  becomes  liable  for 
any  tax  thereon,  unless  he  in  turn  shows  that  actual  own- 
ership does  not  rest  in  him.  Where  the  stockholder  of 
record  continues  to  receive  the  dividends  and  subse- 
quently pays  them  over  to  the  one  claiming  to  be  the 
actual  owner,  or  agent  for  the  actual  owner,  he  should 
ascertain  the  name  and  address  of  the  one  to  whom 
the  payment  is  made,  and,  if  such  payee  is  not  a  non- 
resident alien  or  a  non-resident  foreign  corporation,  the 
nominal  stockholder  is  under  no  further  duty  than,  per- 
haps, to  report  the  name  and  address  of  the  payee  under 
the  provisions  of  law  requiring  information  at  the 
source.  Thus,  if  a  nominal  stockholder  pays  over  the 
dividend  to  a  resident,  even  though  he  knows  such  resi- 
dent to  be  the  agent  of  a  non-resident  alien,  he  is  under 
no  duty  as  agent,  since  it  is  the  one  who  collects  the 
dividend  for  a  non-resident  or  who  finally  pays  it  over 
to  a  non-resident,  who  has  impressed  upon  him  the  duty 
of  agent  within  the  meaning  of  the  preceding  chapter. 

Procedure  When  Actual  Owner  Is  a  Resident  or 
Citizen.  The  Treasury  Department  has  as  yet  issued 
no  regulation  requiring  the  nominal  or  record  owner  of 
stock  to  disclose  the  names  of  actual  owners  who  are  resi- 
dents or  citizens.^  The  primary  purpose  of  requiring 
disclosure  of  the  actual  owner  is  to  assist  in  administer- 
ing that  provision  of  the  1916  Law  which  makes  divi- 
dends on  domestic  stocks  taxable  when  paid  to  non-resi- 
dent aliens  and  requires  withholding  when  paid  to  non- 
resident foreign  corporations."    The  actual  owner  is,  of 

1  The  rulings  on  this  subject  have  not  always  been  consistent 
bat  it  seems  that  the  statements  contained  in  this  chapter  represent 
the  prepent  attitude  of  the  Treasury  Department. 

8  Letter  from  Treasury  Department  dated  November  21,  1916; 
T.  T.  S.  1917, 1 183.  « 


68  b^KUEKAL    INCOMK    TAA 

aurse,  in  all  cases  under  the  duty  of  reporting  the  divi- 
dends and  paying  tax  thereon,  if  he  is  liable ;  the 
nominal  stockholder  is  under  no  duty  to  report  the  divi- 
dends as  his  income,  but  should  be  prepared,  if  question 
arises,  to  show  that  the  actual  ownership  does  not  rest 
in  him. 

Procedure  When  Actual  Owner  Is  Non-Resident. 

Where  the  nominal  stockholder  is  a  resident  of  this 
country  and  is  acting  for,  or  paying  the  dividends  to 
an  actual  owner  who  is  a  non-resident  alien  individual,^ 
or  a  foreign  corporation  or  partnership  having  no  office 
or  place  of  business  in  this  country,  a  certificate  '  should 
be  obtained  by  the  nominal  owner  from  the  actual  owner, 
disclosing  the  facts  of  such  ownership,  which  certificate 
is  required  to  be  forwarded  by  the  nominal  owner  to  the 
collector  of  internal  revenue  in  the  manner  stated  below. 
A  certificate  of  actual  ownership  once  filed  is  held  to  be 
sufficient  until  ownership  changes,  when  it  is  necessary 
to  disclose  the  new  actual  owner,  as  in  the  first  instance. 
In  such  cases,  the  nominal  stockholder  is  deemed  to  be 
an  agent  in  this  country  for  the  non-resident  actual 
owner  and  will  be  required  to  make  a  return  of  net  in- 
come and  to  pay  any  tax  due  on  the  dividends  which  pass 
through  his  hands,  just  as  other  agents  for  non-resideut 
aliens  are  required  to  do  under  the  law.*  The  certificates 
disclosing  actual  ownership  should  be  attached  in  such 
cases  to  the  return  of  income  filed  for  the  actual  owner. 
If  the  amount  of  income  is  so  small  that  no  annual  re- 
turn is  required,  the  certificates  disclosing  actual  own- 

8  This  certificate  is  officially  known  aa  Form  1087. 

4  See  Chapter  6  for  duties  of  agent  as  to  making  returns  and 
paying  tax  for  non-resident  aliens  and  non-resident  foreign  corpo- 
rations. • 


NOMINAL   STOCKHOLDEKS  69 

ership  should  nevertheless  be  filed  with  the  local  collector 
as  proof  of  the  fact  that  the  nominal  stockholder  is  not 
the  actual  owner  of  the  stock.  If  the  actual  owner  is  a 
non-resident  alien  partnership,  the  nominal  owner  is  re- 
quired to  make  no  return  and  account  for  no  tax  unless 
and  until  he  is  so  instructed  by  the  Commissioner  of  In- 
ternal Revenue;  certificates  disclosing  the  actual  owner- 
ship skould,  however,  be  obtained  by  the  nominal  stock- 
holder and  transmitted  to  the  local  collector.* 

Procedure  When  the  Nominal  Stockholder  Is  a  Non- 
Resident  Alien.  When  the  record  owner  of  stock  of 
domestic  or  resident  corporations  is  a  non-resident  alien 
individual  or  partnership,  he  or  it  should  disclose  the 
actual  owner,  or  the  tax  will  be  assessed  on  the  basis  of 
apparent  ownership.  When  the  actual  ownership  is  dis- 
closed, the  Commissioner  of  Internal  Revenue  will  make 
such  assessments  and  issue  such  instructions  to  the  pay- 
ing corporations  in  this  country  as  will  insure  the  proper 
collection  of  the  tax  in  accordance  with  actual  tax 
liabilities.  The  certificates  disclosing  ownership  should 
be  filed  by  non-resident  alien  individuals  and  partner-, 
ships  with  the  Collector  of  Internal  Revenue  at  Balti- 
more, Maryland,  being  attached  to  the  return  of  annual 
not  income  of  the  nominal  stockholder,  if  such  a  return  is 
filed.  In  case  the  non-resident  nominal  stockholder  is  a 
•orporation  or  organization  against  which  the  tax  will  be 
withheld  at  the  source  on  payments  of  dividends,  the 
I  t^rtificate  disclosing  actual  ownership  may  be  filed  with 
the  corporation  paying  the  dividend  or  its  paying  agent 
in  the  United  States,*  and  upon  the  filing  thereof,  the 

B  T.  D.  2401. 

6T.  D.  2452.     The  form  to  be  used  is  romi  1037  strikinjr  out 
tlio  words  "to  he  filed  with  representative  in  the  United  8tate»« 


70  FEDERAL   INCOME   TAX 

paying  corporation  will  not  withhold  the  tax  upon  such 
amounts  as  are  shown  by  the  certificates  disclosing  actual 
ownership  to  be  owned  by  others  than  non-resident 
foreign  corporations  or  organizations  subject  to  with- 
holdirg.  If  the  certificates  disclosing  actual  ownership 
indicate  that  the  actual  owner  is  a  non-resident  foreign 
corporation,  the  corporation  paying  the  dividend  will 
deduct  the  tax  on  the  amounts  of  dividends  paid  to  the 
nominal  stockholder  for  the  account  of  such  non-resident 
foreign  corporation,''  There  is  no  duty  on  the  part  of 
a  non-resident  nominal  stockholder  to  file  any  return  or 
account  for  any  tax  on  behalf  of  the  actual  owner.  That 
duty  is  imposed  only  when  the  nominal  stockholder  is  a 
resident  of  this  country.^  A  foreign  partnership,  al- 
though not  itself  subject  to  tax,  should  file  certificates 
disclosing  the  actual  ownership  of  stock  standing  in  its 
name,  in  order  to  release  its  individual  members  from 
the  tax  liability  which  would  otherwise  attach  on  their 
distributive  shares  of  the  partnership  profits  by  reason 
of  the  apparent  ownership. 

Dutch  Administration  OflSces.  A  sT>eeial  ruling  has 
been  made  with  respect  to  the  so-called  "Administra- 

of  sucli  foreie:n  principal"  in  the  caption  and  the  words  "in  the 
United  States"  in  the  hody  of  the  form,  and  executing  the  certifi- 
cate as  the  representative  of  the  actual  owner  in  the  space  provided 
for  signature. 

7  Letters  from  Treasury  Department  dated  October  6,  1917,  and 
October  23,  1917;  I.  T.  S.  1917,  Tl  2466  and  2467, 

8  T.  D.  2452  seems  to  impos"  such  a  duty  on  non-residents,  but 
a  subsequent  letter  from  the  Treasury  Department  dated  April 
7.  1917  (T.  T.  S.  1917,  112187').  states  that  the  requirements  set 
forth  in  that  T.  D.  to  the  effect  that  the  nom'nal  owner  will  be 
required  to  render  annual  returns  for  and  in  behalf  of  the  actual 
owner  applies  only  to  such  nominal  owners  as  are  residents  of  the 
United  States. 


NOMINAL  STOCKHOLDEKS  71 

tion  Offices"  in  Holland,  which  has  application  to  many 
similar  situations  in  foreign  countries.  It  appears  that 
the  Dutch  Administration  Offices  are  the  registered 
owners  of  large  blocks  of  American  stocks,  against  which 
they  have  issued  bearer  certificates,  with  coupons  at- 
tached. These  coupons  on  presentation  and  surrender 
entitle  the  bearer  to  dividends  declared  on  the  stock.  The 
Administration  Offices  are  held  to  be  agents  for  the 
holders  of  the  bearer  certificates  and  are  prima  facie 
liable  for  the  tax  on  all  dividends  paid  on  the  stock 
standing  in  their  names,  unless  they  disclose  the  names 
of  the  actual  owners  by  use  of  the  proper  certificates.® 
They  are  required  to  make  returns  of  income  and  pay 
the  tax  on  all  dividends  received,  except  such  amounts 
as  are  shown  by  certificates  disclosing  actual  ownership 
to  have  been  received  for  the  account  of  non-resideut 
alien  individuals.  Such  certificates  should  be  attached 
to  the  return  when  filed." 

Bearer  Certificates.  When  stock  of  an  American  cor- 
poration is  floated  in  some  European  countries,  where 
investors  are  accustomed  to  bearer  stock  certificates,  a 
block  of  the  stock  is  sometimes  issued  to  a  trust  com- 
pany in  this  country  which  in  turn  issues  bearer  cer- 
tificates entitling  the  holder  to  certificates  of  stock  for 
the  number  of  shares  designated,  upon  the  surrender  of 
the  bearer  certificate,  and  to  any  dividends  which  may 

»Form  1087. 

10  T.  D.  2386.  The  Treasury  Department  also  provided  in  this 
treasury  decision  for  the  appointment  of  an  agent  in  this  country 
by  such  Administration  Offices,  upon  doing  which  the  tax  will  not 
b«  withheld  at  the  source.  It  seems,  also,  that  by  filing  certificates 
disclosing  actual  ownership  with  the  paying  corporation  withhold- 
ing  at  the  source  may  be  avoided  to  the  extent  indicated  in  T.  D. 
2452. 


72  FEDERAL   INCOME   TAX 

be  declared  on  such  shares  while  the  bearer  certificate 
is  outstanding.  The  bearer  certificates  pass  by  delivery, 
the  dividends  being  claimed  through  foreign  banks  by 
presentation  and  surrender  of  numbered  coupons  at- 
tached thereto.  In  such  cases  the  trust  company  is  in 
the  position  of  a  resident  nominal  stockholder  and  to 
avoid  liability  for  the  tax  on  dividends  received  by  it 
on  such  stock,  should  obtain  and  file  certificates  disclos- 
ing actual  ownership  and  proceed  in  other  respects  as 
indicated  above. 


CHAPTER  8 

ProUCIABEES 

The  law  provides  that '  *  Guardians,  trustees,  executors, 
administrators,  receivers,  conservators,  and  all  persons, 
corporations,  or  associations,  acting  in  any  fiduciary 
capacity,  shall  make  and  render  a  return  of  the  income 
of  the  person,  trust,  or  estate  for  whom  or  which  they 
act,  and  be  subject  to  all  the  provisions  of  this  title 
which  apply  to  individuals. ' '  *  For  the  purpose  of  dis- 
cussion in  this  book  fiduciaries  are  divided  into 
two  classes,  this  chapter  dealing  with  the  subject  in 
general  and  with  the  particular  provisions  applicable 
to  domestic  fiduciaries,  that  is,  those  which  reside  in  this 
country  or  have  an  office  or  place  of  business  here  and 
consequently  are  within  the  jurisdiction  of  this  Govern- 
ment. Foreign  fiduciaries,  which  subject  is  treated  in 
the  following  chapter,  are  defined  for  the  purpose  of 
this  book  as  fiduciaries  who  neither  reside  in  this  coun- 
try nor  have  an  office  or  place  of  business  here,  that  is. 
those  who  are  not  within  the  jurisdiction  of  this  Gov- 
ernment. A  non-resident  citizen  acting  as  a  fiduciary 
would,  it  seems,  be  entitled  to  be  classed  with  the  do- 
mestic fiduciaries  since  the  United  States  has  some 
measure  of  jurisdiction  over  him  as  a  citizen,  and  since 
the  withholding  provisions  of  the  law  do  not  apply  to 
non-resident  citizens. 

1  Art  of  September  8,  1916,  S  8  (c). 

73 


74  FEDERAL  INCOME  TAX 

Who  Are  Fiduciaries.  It  will  be  noted  by  the  pro- 
vision of  the  law  quoted  in  the  preceding  paragraph 
that  an  individual,  a  corporation  or  an  association  may 
be  a  fiduciary  under  the  law.  A  fiduciary  for  income 
tax  purposes  is  one  who  holds  in  trust  an  estate  to 
which  another  has  the  beneficial  title  or  in  which  an- 
other has  a  beneficial  interest,''  or  receives  and  controls 
the  income  of  another  as  in  the  case  of  receivers. 

Agents,  An  agent,  as  such,  is  not  a  fiduciary  for 
his  principal  even  though  he  may  have  complete  charge 
of  the  property  of  his  principal.^  There  may  be  a 
fiduciary  relationship  between  an  agent  and  a  principal 
but  the  word  "agent"  does  not  denote  a  fiduciary 
within  the  meaning  of  the  law.* 

Power  op  Attorney.  A  person  cannot,  by  power 
of  attorney,  appoint  another  to  act  as  a  fiduciary.  A 
person  acting  under  a  power  of  attorney  in  the  man- 
agement of  property,  having  no  title  thereto,  but  with 
full  authority  to  deal  with  the  property  as  he  sees  fit,  is 
merely  an  agent.  A  power  of  attorney  does  not  constitute 
a  fiduciary  relationship,  and,  in  all  cases  where  no  legal 
trust  has  been  created  in  the  estate  controlled  by  the 
agent  and  attorney,  the  liability  under  the  law  to  make 
returns  and  pay  the  tax  rests  with  the  principal.* 

Guardians.  A  legal  guardian  is  a  fiduciary  but  it 
does  not  seem  that  a  natural  guardian  comes  within  the 
definition.     It  has  been  held  by  the  Treasury  Depart- 

8T.  D.  2090. 

ST.  D.  21  .S5. 

4T.  D.  2090. 

6  T.  D.  2137. 


FIDUCIARIES  75 

ment  that  where  a  minor  child  is  in  receipt  of  income, 
the  father,  his  natural  guardian,  cannot  make  a  return 
covering  the  income  of  the  child  but  should  include  the 
income  of  the  minor  as  a  part  of  his  (t^e  father's)  in- 
come for  the  year.®  The  income  of  a  minor  child  can  be 
reported  separately  only  when  a  separate  legal  estate  has 
been  created. 

Trustees.  Trustees  are  expressly  specified  in  the  law 
as  fiduciaries.  They  are  required  to  report  the  income 
of  the  trust  and  the  distributive  interests  therein  of 
the  beneficiaries.  If  a  part  of  the  income  of  the  trust 
for  any  year  is  not  distributed  or  distributable  the  in- 
come tax,  both  normal  and  supertax,  on  that  part,  as  an 
entity,  must  be  reported  by  the  trustee  and  the  tax  paid 
by  him. 

Executors  and  Administrators.  Executors  and  ad- 
ministrators are  fiduciaries  with  respect  to  the  estate  of 
the  deceased  person  under  their  control.  They  are  sub- 
ject to  certain  special  duties  with  respect  to  reporting 
income  of  the  deceased  and  reporting  and  paying  the 
tax  upon  the  entire  income  of  the  estate  during  the 
period  of  administration  or  settlement,  as  more  fully 
indicated  in  the  following  paragraphs. 

Receivers.  A  receiver  for  an  individual  is  a  fiduci- 
ary but  a  receiver  for  a  corporation  is  not."'  It  is  especi- 
ally provided  that  receivers,  trustees  in   bankruptcy, 

•  Letter  from  Treasury  Department  dated  October  30  1916, 
I.  T.  S.  1917,  H  248.  To  hold  otherwise  would,  of  course,  give  end- 
less opportunity  for  evasion  of  the  law. 

7  Letters  from  Treasury  Department  dated  February  27,  1915, 
and  June  22,  1916;  I.  T.  S.  1917,  11  597  and  598. 


76  FEDERAL   INCOME   TAX 

or  assignees  operating  the  property  or  business  of  a 
corporation  shall  make  returns  of  the  income  in  the 
same  manner  and  form  as  is  required  of  corporations, 
and  the  tax  \^iill  be  assessed  and  collected  in  the  same" 
manner  as  if  assessed  directly  against  the  corporation  of 
whose  business  or  properties  they  have  custody  and 
^control.* 

Temporary  Receiver  Held  to  be  Fiduciary.  One 
appointed  under  interlocutory  orders  of  the  United 
States  District  Court  to  act  as  receiver  of  an  individual 
in  a  proceeding  wherein  certain  persons  complaining 
as  creditors  were  seeking  to  have  the  property  of  the 
individual  distributed  among  them,  was  held  to  be  a 
fiduciary,  notwithstanding  that  title  to  the  property 
in  question  (cash  and  securities)  remained  in  the  indi- 
vidual sued  and  that  his  position  and  right  to  deal  with 
the  same  was  only  suspended.  The  receiver  having 
received  income  from  the  property  in  his  possession 
was  required  to  file  a  return  as  a  fiduciary.®  On  the 
amount  reported  in  the  return  as  income,  a  tax  would 
be  paid  as  in  the  case  of  undistributed  net  income  of 
estates. 

Committee  for  an  Incompetent.  The  committee  for 
an  incompetent  person  is  regarded  aS  a  fiduciary.^® 

Who  Are  Beneficiaries.  A  beneficiary  within  the 
meaning  of  the  law  and  the  regulations,  and  in  the 
sense  used  in  this  book,  is  the  ward,  cestui  que  trust, 

8  Act  of  September  8,  1916,  §  13  (c). 

©Letter  from  Treasury  Department  dated  January  22,  1917. 
10  Letter  from  Treasury  Department  dated  February  21,  1916; 
I,  T.  8.  1917,  Hlf  605  and  606. 


FIDUCIARIES  77 

legatee,  distributee,  creditor,  or  other  person  entitled 
to  any  part  of  the  net  income  of  a  trust  or  estate  in 
the  charge  of  a  fiduciary.  The  trust  estate  itself  is 
I  ailed  a  beneficiary  with  respect  to  the  undistributed 
income  of  the  estate. 

Duties  of  Fiduciaries  Generally.  Fiduciaries  are  re- 
quired by  the  law  to  "make  and  render  a  return  of 
the  income  of  the  person,  trust,  or  estate  for  whom 
or  which  they  act,  and  be  subject  to  all  the  provisions 
of  this  title  which  apply  to  individuals."*^  Where 
income  has  been  received  by  an  estate  or  from  any 
kind  of  property  held  in  trust,  the  tax  is  to  be  assessed 
against  the  fiduciary,  unless  (a)  the  income  is  returned 
for  the  purpose  of  the  tax  by  the  beneficiary  or  (b) 
the  income  is  to  be  distributed  annually  or  regularly 
between  existing  beneficiaries,  in  which  case  the  rate 
of  tax  and  method  of  computing  the  same  is  based 
upon  the  amount  of  the  individual  shares  to  be  dis- 
tributed. Fiduciaries  are  indemnified  by  the  law  against 
the  claims  or  demands  of  every  beneficiary  for  all  pay- 
ments of  taxes  which  they  shall  be  required  to  make 
under  this  provision  of  the  law,  and  are  given  credit 
for  the  amount  of  such  payments  against  the  beneficiary 
or  principal  in  any  accounting  which  they  may  make 
as  such  fiduciaries.** 

Duties  of  Executors  and  Administrators.  In  addi- 
tion to  the  duties  which  executors  and  administrators 
have  in  common  with  other  fiduciaries,  they  are  also 
required  under  the  law  to  report  the  income  of  the 
decedent  for  that  part  of  the  last  year  during  which 

11  Act  of  September  8,  1916,  §  8  (c). 
WAct  of  September  8,  1916,  g2  (b). 


78  FEDERAL   INCOME  TAX 

he  lived ;  and  also  for  the  preceding  year  if  the  decedent 
died  before  the  time  for  filing  returns  for  such  year  had 
expired  and  no  return  had  been  filed  by  him.  Thus,  if 
a  decedent  died  in  February,  1917,  without  having  made 
a  return  for  1916,  the  executor  or  administrator  is 
required  to  file  a  return  for  1916  and  a  return  for  the 
part  of  1917  in  which  the  decedent  lived.  The  income 
tax  due  from  a  deceased  person  is  a  debt  against  the 
estate  in  the  hands  of  his  executor  or  administrator 
and  under  the  authority  of  the  law  ^^  the  Treasury 
Department  requires  the  executor  or  administrator  to 
file  a  return  for  the  decedent  covering  the  unreported 
income  received  by  the  decedent  up  to  the  time  of  death, 
in  order  that  the  amount  due  to  the  Government  from 
the  decedent's  estate  may  be  determined  and  paid.** 
If  the  net  income  of  the  decedent,  from  January  1  of 
the  year  in  which  he  died  to  the  date  of  his  death, 
was  less  than  the  sum  which  would  have  made  him  liable 
to  make  a  return  if  living,  no  return  is  required  by  the 
executor  or  administrator.*^  The  personal  exemption 
which  may  be  deducted  from  the  decedent's  income  so 
reported,  under  the  1916  Law  and  the  1917  Law  respec- 
tively, is  the  full  amount  allowed  to  living  persons  of 
the  same  status  as  that  of  the  decedent  at  the  time  of  his 
death." 

Receiver.  Where  a  receiver  for  an  individual,  acting 
under  interlocutory  orders  of  the  court,  receives  income 
during  any  year  on  funds  which  he  holds  in  trust  as 

18  Act  of  September  8,  1916,  §  9  (g). 
14  T.  jy.  2152. 

16  Act  of  October  3,  1917,  §  3 ;  see  also  T.  D.  2090  and  Regs. 
33,  Art.  17. 
16  See  Chapter  4,  paragraph  on  personal  exemption. 


FIDUCIARIES  79 

such  receiver,  such  income  must  be  accounted  for  and 
the  tax  paid  thereon  for  that  year.  The  receiver  is 
indemnified  against  the  claims  or  demands  of  every 
beneficiary  and  shall  have  credit  for  the  amount  of 
such  payments  against  the  beneficiary  or  principal  in 
any  accounting  which  he  makes  as  such  receiver.  The 
income  being  thus  freed  of  tax  liability  imposed  by 
statute,  it  assumes  the  status  of  capital  and  may  there- 
after be  distributed  by  the  receiver  in  the  same  manner 
as  other  capital.  The  fact  that  all  or  any  part  of  the 
income  received  by  a  receiver  may  be  used  to  pay 
creditors  does  not  relieve  the  receiver  from  first  paying 
the  tax  on  all  income  received  by  him,  less  the  deduc- 
tions, credits  and  exemptions  allowed  by  the  law — the 
Government  has  a  prior  lien  for  the  amount  of  the  tax ; 
what  remains  may  be  distributed  to  creditors  or  others.*'' 

Trust  Estates.  In  the  following  discussion  of  the 
subject  of  fiduciaries  the  term  "trust  estates"  is  used 
as  meaning  the  estate  or  property  over  which  the  fidu- 
ciary has  control,  whether  he  be  a  guardian,  trustee, 
executor,  administrator,  receiver,  or  otherwise. 

Income  of  Trust  Estates.  The  income  of  a  trust 
estate  embraces  the  income  from  aD  sources,  as  in  the 
case  of  individuals,  excluding  exempt  income.  The 
chapters  on  the  subject  of  income  should  be  read  in 
this  connection.  The  corpus  of  the  estate,  that  is,  the 
amount  of  the  capital  transferred  to  the  estate  at 
the  time  of  its  creation,  is  not  income.  Thus,  in  the 
case  of  decedents'  estates  the  appraised  value  of 
the  property  at  the  time  of  the  death  of  the  decedent 

17  Letter  from  Treasury  Department  dated  February  9,  1917: 
I.  T.  S.  1917,  f  2008. 


80  FEDERAL   INCOME   TAX 

is  the  capital  of  the  estate,  regardless  of  the  fact  that 
the  cost  of  that  property  to  the  decedent  may  have 
been  much  less.  All  income  derived  from  such  prop- 
erty after  the  death  of  the  decedent  is  income  to  the 
estate.  Income  derived,  by  the  decedent  before  his  death 
is  capital  when  received  by  the  estate.  The  rules  laid 
down  by  the  courts  with  respect  to  the  difference  between 
income  and  capital  in  cases  between  life  tenant  and 
remainderman  do  not  necessarily  apply  under  the  pro- 
visions of  the  income  tax  law,  so  far  as  assessing  the 
tax  is  concerned.  Thus,  extraordinary  dividends  re- 
ceived by  an  estate  are  income  to  the  same  extent  as 
if  received  by  an  individual,  although  a  part  of  the 
fund  from  which  such  dividend  is  declared  may  have 
been  earned  by  the  corporation  prior  to  the  creation 
of  the  estate. 

Deductions  Allowed  Trust  Estates.  A  trust  estate  is 
allowed,  in  general  terms,  the  same  deductions  as  are 
allowed  to  individuals.  The  Treasury  Department, 
however,  has  made  several  special  rulings  with  respect 
to  deductions  which  may  be  claimed  by  fiduciaries 
against  the  income  of  trust  estates  and  these  rulings 
are  given  in  the  following  paragraphs. 

Business  Expenses.  The  usual  and  necessary  ex- 
penses of  carrying  on  a  business  which  may  be  conducted 
by  the  fiduciary  including  salaries,  wages,  rentals, 
repairs  to  business  properties,  etc.,  are  held  to  be  prop- 
erly deductible,  since  they  are  expenses  which  reduce 
the  income  accruing  to  the  beneficiaries.^' 

Expenses  Not  DEDUCTiBitE.  A  distinction  is  made 
between  such  expenses  as  are  properly  chargeable  against 

18  T.  D.  2135. 


FIDUCIARIES  81 

the  corpus  of  an  estate  at  the  time  of  its  creation,  and 
such  other  expenses  incident  to  administration,  as  may 
arise  from  the  nature  of  the  properties  and  the  details 
of  business  management.  Thus,  court  costs,  attorneys' 
fees,  executors'  commissions,  etc.,  are  held  generally  to 
be  expenses  that  reduce  the  corpus  of  the  estate  in 
the  administrator's  hands  and  not  expenses  which 
directly  reduce  the  income  accruing  to  the  beneficiaries. 
Therefore  such  expenses  are  not  a  proper  deduction 
from  the  annual  income.^® 

Executors'  Commissions.  If  under  the  laws  of  the 
state  or  the  terms  of  the  will  or  the  decree  of  a  court 
executors'  commissions  are  deductible  from  the  corpus 
of  the  estate  they  should  not  be  included  as  deductions 
in  the  annual  return  of  the  fiduciary,  but  if  they  are 
to  be  deducted  from  the  income  of  the  estate  dis- 
tributable among  the  beneficiaries  the  amount  should 
be  entered  as  a  legitimate  and  necessary  expense.*® 

Interest.  Any  interest  which  a  trust  estate  may  be 
required  to  pay  to  creditors  is  a  proper  reduction,  except 
interest  or  indebtedness  incurred  for  the  purchase  of 
obligations  or  securities  the  interest  upon  which  is 
exempt  from  the  income  tax.*** 

Taxes.  Any  tax  paid  by  a  trust  estate  is  a  proper 
deduction  to  the  same  extent  as  in  the  case  of  indi- 
viduals or  corporations.  Inheritance  taxes  are  held  not 
to  be  deductible.". 

19  T.  D.  2090;   T.  D.  2135. 

80  Letter    from    Treasury    Department    dated    March    2,    IflM: 
T.  T.  S.   1917;   1660. 
2»«See  Chapter  29. 

21  See  Chapter  30  on  deduction  for  taxes. 
P.  I.  Tax.— 6 


82  '    FEDERAL   INCOME   TAX 

Losses.  Losses  aetually  sustained  during  the  year, 
incurred  in  business  or  trade,  or  arising  from,  fires, 
storms,  shipwreck,  or  other  casualty,  and  from  theft, 
not  compensated  for  by  insurance  or  otherwise  may  be 
deducted  under  the  same  rules  as  are  applicable  to 
individuals.'^^  In  case  the  estate  was  created  prior  to 
March  1,  1913,  a  loss  sustained  by  the  sale  of  property 
is  determined  by  the  fair  market  price  or  value  of  the 
property  as  of  that  date.  If  the  estate  was  created 
subsequent  to  March  1,  1913,  the  loss  is  determined  on 
the  basis  of  the  appraised  value  of  the  property  at  the 
time  the  decedent  died  or  the  estate  was  created.*^ 

Depreciation.  The  general  rules  relating  to  depre- 
ciation ^*  are  modified  in  the  case  of  trust  estates,  by 
the  following  ruling  of  the  Treasury  Department:  In 
the  case  of  a  trust  estate  where  the  terms  of  the  will 
or  trust,  or  the  decree  of  a  court  of  competent  juris- 
diction, provide  for  keeping  the  corpus  of  the  estate 
intact,  and  where  physical  property,  forming  a  part 
of  the  corpus  of  such  estate,  has  suffered  depreciation 
through  its  employment  in  business,  a  deduction  will 
be  permitted  for  depreciation,  if  the  deduction  is  applied 
or  held  by  the  fiduciary  for  making  good  such  depre- 
ciation. No  depreciation  deduction  will  be  permitted  to 
fiduciaries  other  than  as  here  provided.  Fiduciaries 
should  set  forth  in  connection  with  their  returns  the 
provision  of  the  will  or  trust  or  decree  requiring  such 
depreciation  deduction,  where  any  exists,  or  that  actual 
depreciation  occurs,  the  amount  thereof,  and  that  the 

22  See  Chapter  31  on  Deduction  of  losses. 

23  Telegram  from  Treasury  Department  dated  February  3, 
1917;  I.  T.  S.  1917,  11999. 

24  See  Chapter  32. 


FIDUCIAKIES  OO 

same  has  been  or  will  be  reser'\ied  and  applied  as  such. 
The  intent  is  to  deny  to  fiduciaries  the  right  of  claim- 
ing a  deduction  for  depreciation  if  the  amount  of  such 
deduction  is  actually  paid  to  the  beneficiary  as  income. 
This  ruling,  however,  does  not  deny  the  trustee  the 
right  of  making  deductions  for  expenses  actually 
incurred  for  repairs  and  such  other  necessary  expenses, 
other  than  betterments,  as  may  be  required  to  preserve 
the  corpus  of  the  estate.** 

Deu^letion  op  Natural  Resources.  If  an  estate  has 
capital  invested  in  mines  or  oil  or  gas  wells,  depletion 
for  the  exhaustion  of  the  natural  deposits  may  be  claimed 
to  the  same  extent  as  is  permitted  to  individual  owners.*® 

Net  Income  of  Trust  Estates.  The  net  income  of  a 
trust  estate  consists  of  the  amount  of  the  total  taxable 
income  from  all  sources  less  the  amount  of  the  deduc- 
tion permitted  by  law.  From  this  net  income  may  be 
deducted,  for  the  purpose  of  assessing  the  normal  tax, 
the  amount  of  dividends  received  by  the  estate  (which 
amount  has  been  included  in  the  gross  income)  and 
income,  if  any,  on  which  the  normal  tax  has  been  or 
is  to  be  paid  at  the  source.  The  amount  of  net  income 
remaining  after  these  deductions  is  subject  to  the  normal 
and  the  supertaxes  in  the  hands  of  the  respective  bene- 
ficiaries, or  in  the  hands  of  the  estate  with  respect  to 
that  part  which  is  not  distributed  among  the  bene- 
ficiaries. The  amount  of  net  income  represented  by 
dividends,  and  income  on  which  the  normal  tax  has 
been  paid  or  is  to  be  paid  at  the  source,  is  subject  to 

88  T.  D.  2267. 

M  See  Chapters  33  and  34. 


84  •  FEDERAL   INCOME   TAX 

the  supertax  in  the  hands  of  the  beneficiaries  or  in  the 
hands  of  the  estate,  as  the  ease  may  he. 

Distribution  of  Income  of  Trust  Estates.  When  any 
part  of  the  net  income  of  a  trust  estate  for  any  year 
is  distribiTted  to  beneficiaries,  the  fiduciary  is  required 
to  report  the  respective  amounts  paid  or  credited  to 
each  beneficiary.  The  beneficiaries  are  required  to 
report  such  amounts  in  their  personal  returns  and  add 
the  same  to  income  from  other  sources  in  order  to 
determine  their  respective  tax  liabilities.  If  a  bene- 
ficiary is  a  non-resident  alien  the  normal  tax  must  be 
withheld  at  the  source  and  the  fiduciary  will  also  be 
required  to  account  for  the  supertax,  and  to  make 
returns  for  the  non-resident  alien  beneficiary  in  the 
same  manner  as  other  resident  agents  for  non-resi- 
dent aliens  are  required  to  do.^''  If  the  beneficiary 
is  a  minor,  or  is  incompetent,  the  fiduciary  will  be 
required  to  make  the  return  for  him  and  to  pay  the 
tax  for  him  as  his  agent. 

Income  Not  Actually  Paid  to  Beneficiaries  in 
Year.  Fiduciaries  having  control  of  income  accruing 
during  the  year  to  a  known  beneficiary,  whether  or  not 
actually  distributed  or  paid  to  the  beneficiary  during 
the  year,  are  required  to  report  the  name  of  the  bene- 
ficiary to  whom  such  distributive  interest  accrues,  and 
in  all  such  cases  the  tax  is  assessed  to  the  beneficiary 
on  the  basis  of  his  taxable  status.  Where  the  tax  on 
such  annual  income  has  been  paid,  it  is  not  again  pay- 
able when  later  that  income  is  actually  turned  over  to 

27  See  Chapter  6  for  duties  of  resident  agents  for  non-resi- 
dent aliens. 


FIDUCIARIES  85 

the  beneficiary.**  The  theory  seems  to  be  that  sueli 
income  is  separated  from  the  estate  when  it  is  credited 
to  the  beneficiary,  the  fiduciary  thereafter  holding  it, 
not  as  fiduciary,  but  as  agent  for  the  beneficiar>-. 

Distribution  op  Income  of  Several  Years.  Where 
a  decedent  died  in  1913,  leaving  a  will  devising  a  part 
of  his  estate  in  trust  to  pay  the  income  therefrom  to 
one  beneficiary  dui'ing  life,  and  other  parts  to  be  divided 
among  other  beneficiaries,  and  it  was  impracticable  for 
the  executors  to  complete  distribution  of  the  estate  or 
determine  the  amount  of  net  income  until  1916,  at  which 
time  an  account  was  prepared  showing  the  net  income 
accruing  to  each  beneficiary  during  the  last  three  months 
of  1913  and  during  the  years  1914  and  1915,  a  large 
part  of  the  accumulated  income  bein^  distributed  in 
1916,  it  was  held  that  the  executors  should  make  a  fidu- 
ciary return  for  each  of  the  years  1913,  1914,  1915  and 
1916,  reciting  therein  the  respective  beneficiaries  and 
their  interests,  and  the  beneficiaries  could  make  amended 
returns  for  such  of  those  years  in  which  they  would  be 
taxable  by  reason  of  the  amount  so  distributed.**  In 
this  case,  apparently,  the  respective  shares  of  the  bene- 
ficiaries were  known  at  all  times,  but  the  amount  of  net 
income  of  the  estate  was  not  determinable  until  1916. 
Where  the  interests  of  the  beneficiaries  are  not  deter- 
minable, but  the  income  is,  the  rules  discussed  in  the 
following  paragraphs  apply. 

Undistributed  Income  of  Trust  Estates.  The  1913 
Law   was  silent   as   to   the   taxability   of   undistributed 

28  T.  D.  2289,  Reg.  IVS,  Art.  75. 

89  Letter  from  Treasury  Department  dated  March  24,  1917: 
I.  T.  8.  1917:  12172. 


86  FEDERAL.  INCOME  TAX 

income  of  trust  estates.  It  was  first  held  by  the  Treas- 
ury Department  that  if  income  was  added  to  the  corpus 
of  the  estate,  under  a  provision  of  the  will  or  under 
a  statute,  no  tax  would  accrue  with  respect  thereto, 
but  later,  under  that  Law,  it  was  held  that  such  income 
was  taxable,  as  an  estate  could  not  be  without  a  bene- 
ficiary for  income  tax  purposes.  Where  the  beneficiaries 
and  their  beneficial  interests  were  known  the  income  was 
to  be  reported  as  accruing  to  them  and  the  estate  itself 
was  to  be  listed  as  a  beneficiary  as  to  any  of  its  income 
not  otherwise  beneficially  assigned  or  accounted  for.^° 
In  the  case  of  decedents'  estates,  however,  it  was  still 
held  that  the  executor  of  the  es'tate  was  required  to 
make  no  return  for  the  estate  until  the  settlement  thereof 
had  reached  a  stage  where  the  beneficiaries  and  their 
respective  interests  in  the  income  were  determinable, 
at  which  time  returns  should  be  made  showing  the 
annual  accrual,  a  separate  return  being  required  for 
each  tax  year  involved.^^  These  rulings,  however,  do 
not  apply  under  the  express  provisions  of  the  1916  Law 
discussed  in  the  following  paragraphs. 

Income  Received  During  Settlement  of  Decedent's 
Estate,  "Income  received  by  estates  of  deceased  per- 
sons, during  the  period  of  administration  or  settlement 
of  the  estate,  shall  be  subject  to  the  normal  and  addi- 
tional tax,"  the  tax  to  be  assessed  against  the  executor 
or  administrator  and  paid  by  the  estate,  except  when 
the  income  is  returned  for  the  purpose  of  the  tax  by 
the  beneficiary.     If   the   income  is   to   be   distributed 

SOT.  D.  2231. 

31  Letter  from  Treasury  Department  dated  March  4,  1916; 
I.  T.  S.  1917,  11576.  See  also  11575;  T.  D.  2289;  T.  D.  2231  and 
T.  D.  1943. 


FIDUCIARIES  87 

annually  or  regularly  among  existing  heirs  or  legatees, 
or  beneficiaries,  and  the  latter  report  their  respective 
shares,  the  estate  is  not  taxed,  the  rate  of  tax  and  method 
of  computing  the  same  being  then  based  in  each  case 
upon  the  amount  of  the  individual  share  to  be  dis- 
tributed.^* Thus,  where  a  specific  legacy  is  contained 
in  a  will,  the  legatee  has  a  vested  interest  and  is  entitled 
to  the  income  therefrom  during  the  period  of  admin- 
istration and  settlement  of  the  estate.  The  amount  of 
such  income  is  reported  by  the  fiduciary  as  accruing 
to  the  legatee  and  is  not  taxed  as  a  part  of  the  income 
of  the  estate  during  the  period  of  settlement. 

Income  op  Estates  or  Property  Held  in  Trust.  The 
1916  Law  provides  that  "income  of  estates  or  any  kind 
of  property  held  in  trust,"  received  during  the  period 
of  administration  or  settlement,  "including  such  income 
accumulated  in  trust  for  the  benefit  of  unborn  or 
unascertained  persons,  or  persons  with  contingent  inter- 
ests, and  income  held  for  future  distribution  under  the 
terms  of  the  will  or  trust,"  shall  be  subject  to  the 
normal  and  additional  tax  and  be  taxed  to  the  estate, 
"the  tax  in  each  instance,  except  when  the  income  is 
returned  for  the  purpose  of  the  tax  by  the  beneficiary, 
to  be  assessed  to  the  *  •  ♦  trustee."  Where,  how- 
ever, the  income  is  to  be  distributed  annually  or  regu- 
larly among  existing  heirs,  legatees,  or  beneficiaries,  the 
rate  of  tax  and  method  of  computing  the  same  shall 
be  based  in  each  case  upon  the  amount  of  the  individual 
share  to  be  distributed. 

Procedure  in  Reporting  Undistributed  Income.  It 
seems  from  the  provisions  of  the  1916  Law  and  the 

88  Act  of  Septemlier  8,  1916,  8  2  (b). 


88  FEDERAL  INCOME  TAX 

rulings  which  have  been  made  from  time  to  time  under 
the  1913  Law,  that  all  of  the  net  income  of  an  estate, 
for  each  calendar  year,  shall  be  accounted  for  and  be 
subject  to  tax.  If  the  income  is  distributed  to  or  set 
aside  for  the  beneficiaries,  they  will  report  the  amount 
of  their  respective  shares  as  a  part  of  their  income. 
If  the  beneficiaries  are  known,  and  the  intent  of  the 
will  or  deed  of  trust  is  that  the  income  shall  be  dis- 
tributed annually  or  regularly  among  them,  such  bene- 
ficiaries, their  respective  shares  of  such  income  being 
determined,  should  add  the  amount  thereof  to  their 
other  income  for  the  year  and  pay  the  tax  accordingly, 
whether  or  not  their  respet^tive  shares  are  actually  paid 
to  them.  The  trustees,  in  such  cases,  will  report  that 
the  shares  have  been  credited  to  the  beneficiaries  and 
treat  the  amounts  in  the  same  manner  as  though  actually 
paid  out.  If  any  part  of  the  income  is  not  distributed 
annually,  because  the  various  interests  therein  are  not 
known,  the  estate,  as  an  entity,  will  be  reported  as  the 
beneficiary  of  that  portion  of  the  net  income  and  the 
tax  will  be  paid  thereon  by  the  fiduciary.  Where  estates 
are  administered  for  the  purpose  of  accumulating  income 
for  minor  beneficiaries,  or  other  persons  with  contingent 
interests,  the  annual  income  will  be  considered  as  income 
of  the  estate,  from  year  to  year,  assuming  thereupon 
the  status  of  capital  or  corpus  of  the  estate.  If  the 
final  disposition  of  each  year's  income  is  certain,  that 
is,  the  identity  of  .the  beneficiaries  who  will  receive  it 
is  known,  so  that  their  respective  shares  of  such  income 
can  be  segregated  and  set  aside,  for  income  tax  purposes, 
the  returns  may  be  made,  and  the  tax  paid,  in  accord- 
ance with  the  respective  tax  liabilities  of  such  bene- 
ficiaries. In  short,  the  purpose  of  the  1916  Law  is  to 
tax  the  estate,  as  an  entity,  on  all  of  that  income  for 


FIDUCIARIES  89 

any  year  which  cannot  be  definitely  and  legally  assigned 
to  some  beneficiary  as  his  income.  For  the  purpose  of 
the  income  tax,  an  accumulation  of  income,- in  the  hands 
of  a  trustee,  which  cannot  be  taken  or  treated  by  some 
taxable  person  as  his  income,  is  income  to  be  taxed  to 
the  estate.**  If  the  net  income  is,  and  legally  can  be, 
returned  for  the  purpose  of  the  tax  by  a  beneficiary 
other  than  the  estate  or  trust,  it  is  taken  out  of  the  class 
of  undistributed  income. 

Receiver.  A  receiver  in  partition  proceedings  is  re- 
quired to  report  at  the  close  of  each  year  during  the 
pendency  of  the  partition  suit,  the  net  income  collected 
from  the  property  during  such  year,  and  pay  the  tax 
thereon.**  Where  an  executor  under  a  will  is  also  re- 
ceiver in  partition  proceedings  the  income  accruing  to 
him  as  receiver  should  be  reported  separately  and  not 
added  to  the  income  received  by  him  as  executor,  if  the 
receivership  is  separate  and  apart  from  the  matter  of 
administration  and  settlement  of  the  estate. 

Specific  Exemption  to  Trust  Estates.  Before  assess- 
ing the  tax  on  undistributed  net  income  received  during 
the  period  of  administration  or  settlement  of  the  estate 
of  a  deceased  citizen  or  resident  of  the  United  States, 
or  on  the  undistributed  income  of  trust  or  other  estates 
of  citizens  or  residents  of  the  United  States,  the  sum  of 
.$3,000  is  allowed  under  the  1916  Law,  and  !l;l,000  under 
the   1917    Law,   as  a  specific   exemption,    in   addition 

to  the  deductions  provided  by  law  for  determining  the 

• 

88  See  T.  D.  2231,  and  letter  from  Treasury  Department  dated 
October  19,  1915,  I.  T.  8.  1917,  1  581. 

34  letter  from  Treasury  Department  dated  March  14,  1917; 
I.  T.  S,  1917,  12171. 


90  FEDERAL  INCOME  TAX 

net  income.^^  This  specific  exemption,  it  seems,  is  ap- 
plicable to  all  trust  estates  where  the  decedent  was  a 
resident  or  citizen  of  this  country,  or  the  trust  was 
created  by  a  resident  or  citizen  of  this  country,  and  is 
not  dependent  upon  the  status  of  the  persons  who  may 
have  a  contingent  interest  in  the  undistributed  net 
income.  Where  the  beneficiaries  are  known,  the  guar- 
dian, trustee  or  other  fiduciary,  making  a  return  for  the 
beneficiary,  is  allowed  to  claim  the  same  personal  exemp- 
tion on  behalf  of  each  beneficiary  as  the  beneficiary 
would  be  entitled  to  claim  if  the  return  were  made  by 
him. 

Returns  by  Fiduciaries.  Fiduciaries  are  required  to 
make  the  return  of  annual  net  income  on  or  before 
March  1,  in  each  year,  covering  the  income  received  by 
the  trust  estate  during  the  preceding  calendar  year. 
This  return  is  required  to  state  the  total  amount  of 
income  received,  (except  exempt  income)  the  allowable 
deductions  claimed  against  such  income,  the  net  in- 
come, and  the  respective  amounts  distributed  to  the  re- 
spective beneficiaries  or  retained  by  the  estate  as  un- 
distributed income.^® 

By  Whom  Filed.  The  return  is  filed  by  the  fidu- 
ciary having  charge  of  the  trust  estate.  In  making  the 
return,  and  in  all  other  respects,  he  is  subject  to  all 
the  provisions  of  the  law  which  apply  to  individuals. 
Where  there  are  two  or  more  joint  fiduciaries  of  a  trust 
estate,  the  return  may  be  made  by  one  of  the  fiduciaries 

36  Act  of  September  8,  1916,  §  7,  as  amended  by  Act  of  October 
3,  1917,  and  §  3,  Act  of  October  3,  1917. 

36  Act  of  September  8,  1916,  §8  (c),  as  amended  by  Act  of 
October  3,  1917.  See  also  Form  1041,  prescribed  for  use  of 
fiduciaries. 


FIDUCIARIES  91 

and  such  a  return  is  a  sufficient  compliance  with  the  re- 
quirements of  the  act.*"' 

"When  a  Return  Is  Required.  A  return  is  required 
wlienever  the  income  payable  to  any  one  beneficiary  in- 
cluding dividends  exceeds  the  minimum  specified  by 
law.2*  The  1916  Law  provides  that  no  return  of  income 
not  exceeding  $3,000  shall  be  required  "except  as  in  this 
title  otherwise  provided."  The  1917  Law  provides  that 
a  return  shall  be  required  in  case  of  net  incomes  of 
$1,000  or  over,  in  the  case  of  unmarried  persons,  and 
$2,000  or  over  in  the  case  of  married  persons.  No  ruling 
has  yet  been  issued  construing  these  provisions.  Under 
the  1913  Law  a  fiduciary  return  was  required  where 
any  beneficiary's  interest  was  $3,000  or  over,  and  it 
would  seem  that  under  the  present  law  a  return  is  re- 
quired whenever  any  beneficiary's  interest,  or  the  amount 
of  the  undistributed  income,  exceeds  $1,000.^®  In  the 
1913  Law  there  was  no  specific  provision  taxing  the  un- 
distributed income  of  decedents'  estates,  and  it  was  held 
that  no  return  need  be  made  by  fiduciary  until  the 
settlement  of  the  estate  had  reached  a  stage  where  the 
beneficiaries  thereof  and  their  respective  interests  in  the 
income  of  the  estate  were  determinable,  and  thereafter 
a  fiduciary  was  required  to  file  a  return  on  or  before 
March  1st  of  each  year.*®  The  present  law  requires  a 
return  annually  while  the  estate  is  in  process  of  settle- 
ment and  the  payment  of  the  tax  by  the  estate  on  the 
undistributed  income  received  during  that  period. 

37  Act  of  September  8,  1916,  5  8(c),  as  amended  by  Act  of 
October  3,  1917. 

38  Letter  from   Treasury  Department  dated  January  4,   1917; 
I.  T.  S.  1917,  %  1971. 

89  Telegram  from  Treasury  Department  dated  February  1,  1916; 
I.  T.  S.  1917,  11(637  and  6.38. 
40  T.  D.  1943. 


92  •  federal  income  tax 

Fiduciaries  Acting  in  More  Than  One  Estate. 
Where  a  fiduciary  acts  for  a  beneficiary  in  more  than 
one  estate  or  trust  each  estate  requires  a  separate  re- 
turn*^ unless  the  creator  of  the  trust  in  each  instance 
is  the  same  person  and  the  trustee  in  each  instance  is  the 
same  person,  in  which  case,  the  trustee  may  make  a 
single  return  for  all  the  trusts  in  his  hands,  notwith- 
standing the  fact  that  they  arise  from  different  instru- 
ments. This  ruling  is  based  on  the  identity  of  the 
creator  and  the  identity  of  the  trustee  of  the  various 
trusts,  and  not  upon  the  identity  of  the  beneficiaries.*'^ 

Where  Filed.  The  return  of  annual  net  income 
should  be  filed  in  the  collection  district  in  which  the 
fiduciary  resides  or  has  his  place  of  business,  regardless 
of  the  residence  of  the  beneficiaries.  Where  an  estate 
has  two  or  more  joint  fiduciaries  the  return  may  be 
filed  by  one  of  them,  in  the  district  where  he  'resides, 
such  filing  being  sufficient  compliance  with  the  law.*^ 

When  Filed.  The  annual  return  must  in  all  cases 
be  filed  on  or  before  March  1  of  the  year  following  that 
for  which  the  income  is  reported.  Although  a  fiduciary 
may  be  a  corporation,  no  privilege  is  extended  for  the 
filing  of  the  return  for  any  other  period  than  the  calen- 
dar year.  The  same  general  rules  applicable  to  the 
filing  of  returns  by  individuals  apply  to  the  returns  by 
fiduciaries.  The  same  extension  of  time  may  be  granted, 
and  the  same  penalties  are  imposed  for  failure  to  file 
returns.** 

41  T.  D.  2090. 
48  T.  D.  2137. 

43  Act  of  September  8,  1916,  §8(e),  as  amenderi  by  Act  of 
October  3,  1917. 

44  See  Cliapter  35. 


KiDUClARIES  93 

Pkepakatio;^  op  Annual  Return.  The  annual  return 
of  a  trust  estate  is  prepared  in  the  manner  indicated 
on  the  form  supplied  by  the  Government.  No  special 
rules  are  applicable  to  fiduciaries,  except  that  where  the 
fiduciarj'  .still  retains  income  received  during  the  year, 
and  the  beneficiary  is  known,  the  return  should  show 
the  amount  actually  paid  to  the  beneficiary  during  the 
year  and  separately  the  amount  to  which  the  beneficiary 
is  entitled,  but  which  has  not  actually  been  paid  over.** 

How  Signed  and  Sworn  to.  The  law  provides  that 
the  fiduciary  shall  make  oath  that  he  has  suflBcient 
knowledge  of  the  affairs  of  such  person,  trust,  or  estate 
to  enable  him  to  make  such  return  and  that  the  same  is, 
to  the  best  of  his  knowledge  and  belief,  true  and  cor- 
rect.*® When  the  return  is  signed  and  sworn  to  by  an 
individual  as  a  fiduciary  his  full  address  must  be  stated. 
If  the  fiduciary  is  an  organization,  the  return  shall  be 
signed  and  sworn  to  by  the  president,  secretary  or 
treasurer.*'' 

Returns  for  Beneficiaries.  As  a  general  rule  the 
fiduciary  is  not  required  to  make  any  return  for  and 
on  behalf  of  his  beneficiary.  If,  however,  the  fiduciary 
has  l)epn  legally  authorized  to  act  as  agent  for  the  bene- 
ficiary, or  as  attorney-in-fact,  he  may  also  make  and 
file  the  personal  annual  return  of  the  beneficiary  in  the 
same  manner  as  any  other  duly  authorized  agent  may 
do.**    If  the  beneficiary  is  incapable  of  making  his  own 

46  Letter  from  Treasury  Department  dated  February  18,  1916; 
I.  T.  S.  1917,  If  639. 

*BAct  of  September  8,  1916,  (8  (e),  as  amended  by  Act  of 
October  3,  1917. 

47  Reg.  S.-i,  Art.   73. 

48  Reg.  .W,  Art.  72. 


94  FEDERAL   INCOME  TAX 

return,  or  is  a  non-resident  alien,  the  fiduciary  is  re- 
quired to  make  the  personal  return  for  him,  as  indi- 
cated in  the  following  paragraphs. 

For  Minor  or  Insane  Person.  Where  the. fiduciary- 
acts  for  a  single  beneficiary  who  is  a  minor  or  an  insane 
person,  he  is  not  required  to  file  a  fiduciary  return  for 
the  trust  estate  but  will  make  a  personal  return  for  his 
ward  on  the  form  prescribed  for  indi\'iduals.  If,  how- 
ever, a  fiduciary  has  more  than  one  ward  by  reason 
of  the  same  estate  or  trust,  he  makes  the  fiduciary  re- 
turn, and  also  a  separate  return  for  each  ward  having  a 
net  income  of  $1,000,  if  unmarried,  or  $2,000,  if  mar- 
ried.*® In  all  cases  where  fiduciaries  act  for  minors 
or  incompetents  they  are  held  for  the  purpose  of  the 
income  tax  to  be  acting  as  the  agents  of  such  minors 
or  incompetents  and  must  pay  all  tax,  normal  and  addi- 
tional, chargeable  on  such  income  in  their  hands,  as 
though  the  persons  for  whom  they  act  were  acting  for 
themselves.^**  In  the  year  in  which  a  minor  becomes  of 
age,  the  guardian  should  make  a  fiduciary  return  for 
the  period  between  the  beginning  of  the  year  and  the 
day  on  which  the  beneficiary  becomes  of  legal  age.  At 
the  close  of  the  year  the  beneficiary  makes  his  own  re- 
turn including  therein  the  amount  of  income  received 
from  the  fiduciary  during  the  year. 

For     Non-Resident     Alien    Beneficiaries.    When 
there   is   only   one   beneficiary,  who  is   a  non-resident 
alien,  the  fiduciary  files  only  one  return,  that  is.  the 
personal  annual  return  for  and  on  behalf  of  the  non- 
49  t.  D.  2090. 
50  T.  T).  2231. 


FIDUCIAlUJiS  y5 

resident  alien,*^  signing  the  same  as  agent,  reporting 
therein  as  income  of  the  non-resident  beneficiary  the 
amount  received  bj'  the  estate  or  trust.  If  there  are 
two  or  more  beneficiaries,  or  if  a  part  of  the  income 
accruing  to  the  trust  or  estate  is  not  distributed,  the 
fiduciary  is  required  to  make  a  return  as  fiduciary 
and  a  separate  personal  return  for  each  non-resident 
alien  beneficiary.**  The  fiduciary  must  account  for 
the  normal  and  additional  tax  of  non-resident  alien 
beneficiaries  in  the  same  manner  as  any  other  agent 
for  a  non-resident  alien  is  required  to  do.'^ 

Income  to  Be  Reported  by  Beneficiary.  As  stated  in 
the  foregoing  part  of  this  chapter  unless  the  beneficiary 
is  under  some  disability  which  requires  a  fiduciary  to 
act,  the  beneficiary  makes  his  own  personal  return  and 
accounts  for  the  tax  upon  his  entire  net  income,  in- 
cluding that  which  has  been  received  from  the  estate.** 
The  fiduciary  is  not  under  any  duty  to  account  for  or 
pay  the  tax  on  amounts  distributed  to  beneficiaries 
where  the  beneficiary  is  capable  of  making  his  own  re- 
turn and  is  not  a  non-resident  alien.  The  beneficiary 
reports  the  income  for  the  year  in  which  it  is  received 
by  him  or  credited  to  him.  The  amount  to  be  reported 
by  the  beneficiary,  as  his  income  from  the  trust  estate, 
is  the  amount  actually  received  from  the  fiduciary  or 
actually  credited  to  him,  as  his  income,  by  the  fiduciary, 
that  is,  the  actual  amount  of  income  to  which  he  ob- 
tains legal  title  during  the  year.** 

51  Form  1040  is  the  form  to  be  used  for  this  purpose. 
»2  T.  D.  2313. 

63  See  Chapter  6. 

64  T.  D.  2090. 

66  Act  of  September  8,  1916,  8  2  (b). 


96  FEDERAL   INCOME   TAX 

Withholding  at  the  Source  Against  Fiduciaries.  The 
provisions  with  respect  to  withholding  the  tax  at  the 
source  apply  in  the  case  of  payments  to  fiduciaries  in 
the  same  manner  as  in  the  case  of  payments  to  indi- 
viduals. There  is,  generally  speaking,  no  withholding 
at  the  source  on  payments  to  citizens  and  residents  of 
this  country  and,  it  follows,  there  is  no  withholding  at 
the  source  in  the  case  of  a  fiduciary  who  is  a  citizen  or  a 
resident,  or  has  an  office  or  place  of  business  in  this 
country.  The  one  exception  to  this  rule  is  the  with- 
holding of  one  2%  normal  tax  on  interest  paid  on  obli- 
gations of  corporations  containing  a  tax-exempt  cove- 
nant. In  such  cases  the  tax  is  in  theory  withheld,  but 
not  in  actual  fact,  since  the  paying  corporation  assumes 
the  burden  of  the  tax,  paying  the  interest  in*  full  to  its 
bondholder.  Although  the  fiduciary  may  be  a  corpora- 
tion, in  its  capacity  as  fiduciary,  it  is  subject  to  the  pro- 
visions of  law  applicable  to  individuals  and  not  to  cor- 
porations, hence  on  payments  of  such  interest  as  that 
referred  to  in  the  preceding  sentence,  the  paying  cor- 
poration will  be  required  to  treat  the  corporation  fidu- 
ciary as  an  individual  and  assume  the  burden  of  the 
2%  tax.66 

Withholding  at  the  Source  by  Fiduciaries.  A  fidu- 
ciary is  under  the  same  duty  to  withhold  the  tax  at 
the  source  as  is  an  individual,  partnership  or  corpora- 
tion, that  is,  the  tax  is  withheld  at  the  source  upon 
all  annual  or  periodical  payments  of  fixed  and  deter- 
minable income  to  non-resident  aliens  in  the  manner 
required  by  the  law.*'''     No  withholding  by  a  fiduciary 

56  See  Chapter  41  on  collection  at  the  source. 
67  Id. 


FIDUCIARIES  1)7 

is  required  in  the  case  of  payments  to  citizens  or  resi- 
dents of  this  country  or  to  corporations  or  partnerships. 

Information  at  the  Source.  The  fiduciary  is  subject 
to  all  the  provisions  of  the  law  requiring  information 
at  the  source.  These  requirements  are  discussed  in  full 
in  a  subsequent  cljapter.** 

68  See  Chapter  40  on  information  at  the  source. 


F.  I.  Tax. — 7 


CHAPTER  9 

FOREIGN  FIDUCIARIES 

The  law  provides  that  * '  guardians,  trustees,  executors, 
administrators,  receivers,  conservators,  and  all  persons, 
corporations,  or  associations,  acting  in  any  fiduciary 
capacity,  shall  make  and  render  a  return  of  the  income 
of  the  person,  trust,  or  estate  for  whom  or  which  they 
act,  and  be  subject  to  all  the  provisions  of  this  title  which 
apply  to  individuals. ' '  ^  The  law  implies  that  foreign 
fiduciaries  shall  be  subject  to  its  provisions  to  the  same 
extent  as  non-resident  alien  individuals.  The  term 
"foreign  fiduciaries"  is  defined,  for  the  purpose  of  this 
book,  as  fiduciaries  who  neither  reside  in  this  country 
nor  have  an  office  or  place  of  business  here,  that  is,  those 
who  are  not  within  the  jurisdiction  of  this  Government. 
The  preceding  chapter  contains  the  general  rules  relating 
to  fiduciaries.  This  chapter  treats  of  the  application  of 
those  rules  to  foreign  fiduciaries.  As  to  who  are  fidu- 
ciaries and  who  are  beneficiaries  within  the  meaning  of 
the  law,  and  as  to  the  special  duties  of  executors,  ad- 
ministrators and  receivers  see  the  preceding  chapter. 

Trust  Estates.  The  trust  estate  under  the  control  of 
a  foreign  fiduciary  is  subject  to  tax  on  net  income  de- 
rived from  sources  within  this  country.    Net  income  from 

1  Act  of  September  8,  1916,  §8  (c),  as  amended  by  Act  of 
October  3,  1917. 


KOKEIUN    F1UUGUK1£S  99 

sources  within  this  country  is  determined  under  the 
same  rules  as  apply  to  non-resident  aliens.*  The  deduc- 
tions claimed  by  the  foreign  fiduciary  are  governed  by 
the  rules  relating  to  fiduciaries  in  general,  except  so  far 
as  they  are  limited  by  rules  relating  to  deductions  of 
non-resident  aliens. 

Distribution  of  Income  of  Trust  Estates.  A  foreign 
fiduciary  having  charge  of  an  estate  or  trust,  the  net 
income  of  which  is  distributed  annually  or  periodically 
among  non-resident  alien  beneficiaries,  is  required  to 
execute  the  same  annual  return  ^  as  is  required  of  domes- 
tic or  resident  fiduciaries  and  a  personal  return  *  on  be- 
half of  each  non-resident  alien  beneficiary.*  If  the 
foreign  fiduciary  has  only  one  beneficiary  who  is  a  non- 
resident alien  to  whom  all  of  the  income  is  distributed 
annually  it  is  necessary  to  file  only  the  personal  return 
on  behalf  of  the  beneficiary  and  not  a  return  for  the  trust 
estate.  If  the  foreign  fiduciary  acts  for  beneficiaries 
who  are  citizens  or  residents  of  this  country  no  personal 
return  need  be  filed  on  behalf  of  such  beneficiaries,  but 
a  return  of  the  trust  estate  must  be  filed,  showing  the 
names  of  such  beneficiaries,  among  others,  and  amounts 
of  income  distributed  to  them  during  the  year.  The 
discussion  in  the  preceding  paragraph  on  the  subject  of 
distribution  of  income  of  trust  estates  should  be  read  in 
this  connection. 

Undistributed  Income  of  Trust  Estates.  For  the 
meaning  of  the  term  undistributed  income  of  trust  estates 

8  See  Chapter  5. 

3  Form  1041. 

4  Form  1040. 

6  Letter  from  Treaaury  Department  dated  December  28,  19J6; 
I.  T.  S.  1917.  f  196.1. 


100  FEDERAL   INCOME  TAX 

see  the  discussion  in  the  preceding  chapter.  If  a  foreign 
fiduciary  has  charge  of  an  estate  in  process  of  adminis- 
tration or  settlement,  or  a  trust  estate  in  which  net  in- 
come from  sources  within  the  United  States  remains 
undistributed  at  the  close  of  the  calendar  year,  a  return 
is  required  ^  listing  the  estate  as  beneficiary  of  such  un- 
distributed net  income.  The  tax  will  thereupon  be  as- 
sessed on  the  undistributed  income  against  the  estate  as 
an  entity  and  the  fiduciary  will  be  required  to  pay  both 
normal  and  supertaxes  thereon.''  If  the  estate  was 
created  by  a  citizen  or  resident  of  this  country,  the  non- 
resident alien  may  claim  a  specific  exemption  from  the 
net  income  thereof,  as  indicated  in  the  preceding  chap- 
ter, but  if  created  by  anyone  not  a  citizen  or  resident,  no 
such  exemption  may  be  deducted. 

Return  of  Annual  Net  Income.  Foreign  fiduciaries 
are  required  to  make  a  return  of  the  annual  net  income 
of  the  estate  from  sources  within  this  country,  on  or 
before  March  1  in  each  year  covering  the  income  re- 
ceived by  the  trust  estate  during  the  preceding  calendar 
year.  This  return  is  required  to  state  the  total  amount 
of  income  received  from  sources  within  this  country  (ex- 
cept exempt  income,)  the  deductions  claimed  against 
such  income,  the  net  income,  and  the  respective  amounts 
distributed  to  the  beneficiaries  or  retained  by  the  estate 
as  undistributed  income. 

By  Whom  Filed.  The  return  is  filed  by  the  fiduciary 
having  charge  of  the  trust  estate.  In  making  the  re- 
turn he  should  comply  with  the  law  and  regulations 

6  Letter  from  Treasury  Department  dated  December  28,  1916 ; 
I.  T.  S.  1917,  H  1963. 

7  See  Chapter  10  on  undistributed  income  of  trust  estates. 


FOREIGN   FIDUCIARIES  101 

respecting  returas  by  non-resident  aliens.  Where  there 
are  two  or  more  joint  fiduciaries  of  a  trust  estate  the 
return  may  be  made  by  one  of  the  fiduciaries." 

When  a  Return  Is  Required.  It  seems  that  the  law 
requires  a  return  whenever  the  net  income  from  sources 
within  this  country  payable  to  any  beneficiary,  or  remain- 
ing undistributed  at  the  end  of  the  year  is  $1,000  or 
over.' 

Where  Filed.  In  the  case  of  foreign  beneficiaries  the 
return  should  be  filed  with  the  Collector  of  Internal 
Revenue  at  Baltimore,  Maryland. 

When  Filed.  The  annual  return  must  in  all  eases  be 
filed  on  or  before  March  1  in  the  year  following  that  for 
which  the  income  is  reported.  The  same  general  rules 
are  applicable  to  the  filing  of  returns  by  non-resident 
aliens  and  by  foreign  fiduciaries.  The  same  extension  of 
time  may  be  granted  and  the  same  penalties  are  imposed 
for  neglect  or  failure  to  file.*® 

Withholdmg  at  the  Source  Against  Foreign  Fiduci- 
aries. The  provisions  with  respect  to  withholding  the 
tax  at  the  source  apply,  in  the  case  of  payments  to 
foreign  fiduciaries,  in  the  same  manner  as  in  the  case 
of  payments  to  non-resident  aliens.  A  foreign  fiduciary 
cannot  claim  exemption  from  withholding  of  the  tax  at 
the  source,**  but  may  claim  the  benefit  of  deductions 

>  Act  of  September  8,  1916,  $  8  (e),  as  amended  by  Act  of 
October  3,  1917. 

9  See  the  discussion  under  this  heading;  in  Chapter  5. 

10  See  Chapter  35  on  return  of  annual  net  income. 

11  Letter  from  Treasury  Department  dated  December  28,  1916; 
I.  T.  S.  1917, 1 1963. 


1U2  KKUliKAL    INCOME   TAX 

and  credits,  and  obtain  a  refund  of  any  amounts  with- 
held in  excess  of  the  tax  lial^ility  of  the  estate,  in  the 
same  manner  as  is  prescribed  with  respect  to  non-resident 
alien  individuals.^^ 

Withholding  at  the  Source  by  Foreign  Fiduciaries. 

Since  a  foreign  fiduciary  is  not  personally  within  the 
jurisdiction  of  this  Government  it  seems  that  the  re- 
quirements imposed  upon  others  to  withhold  the  tax  in 
paying  net  income  to  non-resident  aliens,  do  not  apply 
to  such  fiduciaries.  A  foreign  fiduciary  is  required  to 
report  the  names  of  the  beneficiaries  of  the  trust  estate 
upon  which  information  the  Government  will  collect  the 
tax  from  the  beneficiary. 

Information  at  the  Source.  It  does  not  seem  that  a 
foreign  fiduciary  is  under  any  duty  to  supply  the  Gov- 
ernment with  information  at  the  source  as  to  payments 
made  to  others,  except  so  far  as  information  is  supplied 
with  respect  to  beneficiaries  by  the  return  of  annual  net 
income.  In  any  event  there  is  no  duty  imposed  upon  the 
foreign  fiduciary  until  demand  is  made  by  the  Commis- 
sioner of  Internal  Revenue  for  such  information. 

12  See  Chapter  5. 


CHAPTER  10 

PARTNERSHIPS 

The  law  provides  for  the  taxation  of  individuals  and 
corporations.  Partnerships,  as  such  are  not  taxable,  but 
persons  carrying  on  business  in  partnership  are  liable 
for  the  income  tax,  in  their  individual  capacity,  on  the 
share  of  the  profits  of  the  partnership  to  which  they 
are  or  would  be  entitled  as  partners,  whether  the  profits 
are  divided  or  kept  in  the  business.^  Section  10  of  the 
1916  Law,  imposing  the  tax  on  corporations,  expressly 
excludes  partnerships.  This,  however,  has  been  held 
by  the  Treasury  Department  to  mean  only  general  part- 
nerships such  as  were  known  to  and  existed  under  the 
common  law.  All  other  forms  of  partnerships  are  taxed 
in  the  same  manner  as  corpyorations.  For  the  purpose 
of  the  discussion  in  this  and  the  following  chapter, 
general  partnerships  are  divided  into  two  classes,  domes- 
tic and  foreign,  A  domestic  partnership  is  defined  as 
one  which  has  its  principal  place  of  business  in  this 
country  and  directs  all  or  the  greater  part  of  its  business 
from  its  office  or  offices  in  this  country,  w'hether  or  not 
the  partners  are  citizens  or  aliens,  residents  or  non- 
residents. The  definition  of  "foreign  partnership"  is 
found  in  the  following  chapter. 

Limited  Partnerships.  Limited  partnerships  are  held 
to  be  in  the  same  category  as  corporations  or  associa- 

1  Act  of  September  8,  1916,  as  amended,  18,  Subdivision  (e): 
T.  D.  1957. 


104  FEDERAL   INCOME  TAX 

tions  and  subject  to  the  income  tax  imposed  on  such 
entities.  The  profits  of  limited  partnerships  so  report- 
ing are  treated  as  dividends  and  are  not  subject  to  the 
normal  tax  in  the  hands  of  the  partners  receiving  them.^ 
A  limited  partnership  is  a  form  of  business  organiza- 
tion created  by  statute  in  many  of  the  United  States, 
wherein  the  liability  of  certain  special  partners,  who 
contribute  a  specific  amount  of  capital,  is  limited  to 
the  amount  so  contributed,  while  the  general  partners 
of  the  same  partnership  are  jointly  and  severally 
responsible  as  in  ordinary  partnerships.  The  purpose 
of  a  limited  partnership  is  to  protect  the  special  partner 
and  to  enable  him  to  employ  his  wealth  in  trade  without 
risking  more  than  he  originally  contributed.  As  thus 
defined,  a  limited  partnership  has  always  one  or  more 
partners  who  have  contributed  the  capital  to  the  firm, 
and  are  therefore  entitled  to  receive  a  portion  of  the 
profit,  yet  who  are  unknown  in  the  management,  and, 
so  far  as  the  conduct  of  the  business  is  concerned,  may 
be  said  to  occupy  a  position  analogous  to  that  of  stock- 
holders in  corporations.  In  such  limited  partnerships 
there  exists  no  element  of  principal  or  joint  agency  so 
far  as  the  special  partner  or  partners  is  concerned  and 
the  only  element  of  agency  found  in  the  business  is 
among  the  general  partners.  The  Treasury  Department 
therefore  holds  that  a  limited  partnership  may  very 
properly  be  classed  as  a  quasi-corporation  or  association 
within  the  meaning  of  the  law.^ 

2Eeg.  33,  Art.  86;  T.  D.  2137.  Under  the  1909  Law  it  was 
held  that  a  limited  partnership  was  liable  for  the  tax,  if  organized 
for  profit  and  having  a  capital  stock  represented  by  shares, 
although  no  "certificates  of  stock"  were  issued.  (Op.  Atty.  Gen. 
Feb.  14,  1910.) 

8  In  a  letter  dated  January  19,  1916,  written  with  particular 
reference  to  limited  partnerships  of  the  type  created  under  the 


PABTNERSHIPS  105 

Dividends  prom  Limited  Partnerships.  Since  a  lim- 
ited partnership  is  treated  as  a  corporation  and  is 
required  to  make  returns  in  the  same  manner  as  cor- 
porations, its  profits  should  be  treated  by  the  members 
of  the  partnership  the  same  as  dividends  of  corpora- 
tions.* Members  of  limited  partnerships  should  there- 
fore ascertain  if  the  partnership  is  paying  a  tax 
according  to  this  requirement  and  if  so  the  normal  tax 
should  not  again  be  paid  on  -their  shares  of  the  profits. 

Partnership  Associations.  Under  the  Corporation 
Excise  Tax  Law  of  August  5,  1909,  the  Attorney  General 
held  that  partnership  associations  organized  under  the 
laws  of  Pennsylvania,  possessing  every  privilege  and 

New  York  Statute,  Laws  of  1897,  Ch.  427,  §  3D,  the  Tr-Jasury 
Department  gives  its  reasons  for  classing  limited  partnerships 
with  corporations.  After  quoting  the  language  of  what  is  now 
§  10  (a)  of  the  Act,  which  imposes  a  tax  on  "every  corporation, 
joint  stock  company  or  organization  or  insurance  company 
•  •  *  but  not  including  partnerships"  the  letter  states  that 
the  term  "partnership"  as  there  used  is  a  common  law  term  and 
applies  only  to  such  partnerships  as  were  known  to  the  common 
law.  A  limited  partnership  is  a  distinct  creature  of  the  statutes 
of  the  several  states  and  while  it  possesses  some  of  the  character- 
istics of  the  common  law  partnership,  it  possesses  other  distinct 
characteristics  which  render  it  more  in  the  nature  of  an  associa- 
tion— that  is  a  corporation  in  form,  without  a  specific  charter. 
Corporations,  joint  stock  companies,  as'ociations  and  limited  part- 
nerships are  all  held  to  be  entities  and  only  those  entities  which 
are  specifically  enumerated  in  the  Act  as  exempt  from  its  require- 
ments can  be  relieved  from  liability  under  the  law.  Since  Con- 
gress had  in  mind,  evidently,  only  common  law  partnerships  in 
providing  for  the  exemption  of  th's  class  of  business  organ'zaf  ons 
it  fol'ows  that  any  other  organization,  particularly  such  an  entity 
as  exists  by  rea<-on  of  statutory  provision,  does  not  come  within 
the  exemption  provided. 
4T.  D.  2137. 


106  FEDERAL    INCOME   TAX 

power  essential  to  a  corporation  were  properly  taxable 
as  corporations.^  Such  associations  have  capital  con- 
tributed by  the  partners,  who  are  not  individually  liable 
beyond  the  unpaid  capital  subscribed  by  each.  The 
other  characteristics  which  are  more  in  the  nature  of 
a  corporation  than  of  a  partnership  are  that  the  word 
"Limited"  must  be  a  suffix  to  the  name,  the  interest 
of  a  partner  may  be  transferred  and  new  partners  may 
be  taken  in  by  vote  of  a  majority  of  the  partners,  and 
the  association  may  sue  or  be  sued  in  the  association 
name. 

Private  Banks.  Private  banks  which  transact  busi- 
ness not  in  the  name  of  the  bank  but  in  the  name  of 
individuals  who  compose  the  firm  are  held  to  be  copart- 
nerships and  as  such  are  not  required  to  make  returns. 
If,  however,  the  bank  has  the  form  of  a  corporate 
organization,  elects  officers  and  a  board  of  managers, 
has  a  distinct  name,  a  fixed  situs,  and  distributes  its 
net  earnings  upon  the  basis  of  the  amount  of  capital 
invested  by  the  members  or  owners,  it  is  held  to  be  an 
association  within  the  meaning  of  the  law  and  is  required 
to  make  returns  as  such,  unless  the  bank  is  owned  entirely 
by  one  man,  in  which  case  it  is  treated  as  the  business 
of  an  individual.* 

General  Partnerships.  A  general  partnership,  or 
what  is  known  as  a  common  law  partnership,  which 
Congress  clearly  intended  to  be  exempt  from  the  require- 
ments of  the  income  tax  law,  is  one  w^hich  does  not  have 
a  separate  entity,  but  is  composed  of  two  or  more  indi- 
viduals associated  together  for  the  purpose  of  carryinp: 

6  28  Op.  Atty.  Gen.  189   (1910). 
ST.  D.  2137. 


PAKTNERSHIPS  107 

ou  a  given  business  or  transaction.  Such  a  partnership 
has  been  defined  by  the  courts  as  "a  business  organiza- 
tion in  which  evei*y  partner  possesses  full  power  and 
absolute  authority  to  bind  all  the  partners  by  his  acts 
or  contracts  in  relation  to  the  business  of  the  firm,  in 
the  same  manner  and  to  the  same  extent  as  if  he  held 
full  power  of  attorney  from  them."  Among  the  prin- 
cipal elements  of  a  general  partnership  are  community 
of  ownership  of  the  partnership  property,  mutual  respon- 
sibility and  powers  in  the  conduct  of  the  partnership 
business,  mutual  liability,  joint  and  several,  for  the 
debts  of  the  partnership  and  mutual  interest  in  the 
profits  of  the  same.  Such  partnerships  are  not  subject 
to  the  tax,  but  the  partners  are  taxed  on  their  respective 
shares  of  the  profits.'' 

Partnerships  Operating  Abroad.  No  distinction  is 
nuuU'  ill.  the  law  or  regulations  between  domestic  part- 
nt'i*sliips  which  operate  entirely  within  this  country 
and  those  which  operate  partly  abroad.  A  partner's 
share  of  the  net  profits  of  the  partnership  is  in  all  cases 
taxable  in  full  if  the  partner  is  a  resident  or  citizen 
of  this  country.  If  a  partner  is  a  non-resident  alien 
many  questions  arise  as  to  the  extent  to  which  he  is 
properly  taxable  on  the  gains  from  business  of  the  part- 
nership conducted  abroad.  If  the  partnership  is  a  lim- 
ited partnership  association  under  the  provisions  of  some 
statute,  the  Government  will  undoubtedly  hold  that  the 
partner  is  taxable  to  the  same  extent  as  though  it  were 
a  corporation,  but  if  it  is  a  general  partnership  operat- 
ing partly  in  a  foreign  country,  the  entire  income  there- 
from can  scarcely  be  considered  as  income  arising  within 
the  United  States  even  though  the  partnership  has  an 

7  Reg.  33,  Art.  94. 


108  PEDERAIi  INCOME  TAX 

office  in  this  country  and  the  income  is  paid  to  the 
partner  from  that  office,  since  a  general  partnership  is 
not  a  separate  entity  interposed  between  the  individual 
and  the  source  of  the  income. 

Procedure  in  Collecting  Income.  A  domestic  part- 
nership is  not  subject  to  the  withholding  at  the  source, 
since  it  is  not  the  income  of  the  partnership  but  the 
income  of  the  respective  partners  which  is  subject  to 
tax.  Therefore  the  provisions  of  law  relating  to  collec- 
tion at  the  source  do  not  apply  to  partnerships,  except 
to  the  extent  that  a  partnership  may  be  required  to 
establish  its  identity  and  status  by  filing  a  certificate  or 
statement  showing  it  to  be  a  partnership,  upon  the  filing 
of  which  no  tax  will  be  withheld.'  Partnerships  as  well 
as  all  other  recipients  of  income  will  be  required  to 
disclose  their  identity  in  the  case  of  receiving  fixed  and 
determinable  income  from  another  under  the  provisions 
of  law  as  to  Information  at  the  Source.® 

Duty  in  Paying  Out  Income.  A  partnership  is  under 
the  same  duty  in  paying  out  income  as  is  an  individual 
or  a  corporation,  that  is,  in  all  cases  required  by  law 
the  tax  must  be  withheld  upon  payments  to  non-resident 
aliens  and  information  as  to  the  name  and  address  of 
the  recipient  must  be  obtained  upon  payment*  to  other 
individuals  or  corporations  and  partnerships.^® 

Net  Income  of  Partnerships.  While  the  law  is  silent 
as  to  the  manner  of  computing  the  net  income  of  part- 

8T.  D.  1957;  T.  D.  1998.  See  Chapter  41  on  Collection  at  the 
Source. 

9  See  Chapter  40  on  Information  at  the  Source. 

10  See  Chapters  on  Collection  at  the  Source  and  Information 
at  the  Source. 


PARTNERSHIPS  109 

nersKips  it  follows  that  since  the  partners  are  subject 
to  tax  on  the  distributive  shares  of  the  profits,  the  net 
income  should  be  ascertained  in  general  under  the  same 
rules  as  apply  to  individuals.^* 

Deductions.  The  deductions  to  which  a  partnership 
is  entitled  are  not  stated  in  the  law,  but  it  would  seem 
that  deductions  of  expenses,  interest,  taxes,  losses,  depre- 
ciation and  depletion  should  be  made  by  general  partner- 
ships under  rules  applicable  to  individuals.  In  the 
case  of  limited  partnerships  reporting  as  corporations, 
the  deductions  should  be  made  under  the  rules  applicable 
to  corporations.  Such  special  rulings  as  have  been  made 
with  respect  to  deductions  of  partnerships  are  given 
below. 

Profit  Sharing.  Where  a  partnership  agreed  with 
an  expert  to  take  charge  of  one  of  its  departments  upon 
a  participation  of  profits  basis  by  which  the  expert 
served  without  salary  and  received  his  compensation  in 
the  form  of  20%  of  the  net  profits  of  the  department 
at  the  end  of  the  year,  it  was  held  that  this  arrangement 
established  the  relation  of  employer  and  employee,  not 
that  of  partner,  and  that  the  amount  of  compensation 
paid  to  the  expert  constituted  a  proper  item  of  business 
expense  to  be  deducted  in  computing  the  taxable  income 
accruing  to  the  partnership  members.*" 

Insurance  Premiums.  Premiums  paid  on  life  insur- 
ance policies  covering  the  lives  of  partners  or  employees 

11  This  manner  of  determining  net  income  is  expressly  required 
of  partnerships  in  making  the  special  returns  which  the  law 
authorizes  the  (Commissioner  of  Internal  Revenue  to  demand  at 
any  time.     Act  of  September  8,*I916,  §8  (e). 

12  Letter  from  the  Treasury  Department  dated  June  30,  1916; 
I.  T.  S.  1917,  H  512. 


110  FEDERAL    INCOME   TAX 

are  not  permitted  to  be  deducted  in  computing  the 
profits  of  a  partnership  for  the  purpose  of  determining 
the  distributive  shares  of  the  partners.^^  On  the 
maturity  of  such  policies  the  amounts  of  premiums  so 
paid  (if  not  deducted  from  the  net  income  of  the  years 
in  which  paid)  will  be  a  proper  deduction  from  the 
amount  of  the  policy,  the  remainder  constituting  the 
taxable  portion  of  the  amount  received. 

Interest.  Partnerships  may  deduct  interest  paid 
during  the  year  to  the  same  extent  as  individuals,  and 
subject  to  the  same  limitation  in  the  case  of  interest 
paid  on  money  borrowed  for  the  purchase  of  bonds  the 
interest  on  which  is  exempt  as  income.^* 

Distribution  of  Partnership  Profits.     The  law  has  not 

been  construed  at  any  time  to  require  the  collection  of 
the  tax  at  the  source  on  the  distribution  and  payment 
of  profits  of  a  partnership  to  the  partners.  No  ruling 
has  yet  appeared  requiring  such  deduction  on  payments 
to  non-resident  alien  partners.^^ 

Profits  to  Be  Reported  by  Partners.  The  annual  net 
profits  of  a  partnership  when  divided  and  paid  to  the 

13  Act  of  September  8,  1916,  as  amended  by  Act  of  October  3, 
1917,  §  32.  Under  the  1916  Law  prior  to  this  amendment  the 
Treasury  Department  permitted  such  premiums  on  life  insurance 
to  be  deducted  from  year  to  year  as  paid  and  required  the  amount 
of  the  policy  to  be  included  in  gross  income  in  the  year  in  which 
the  policy  matured  and  such  amount  was  received.     (T.  D.  2090.) 

14  See  Chapter  29. 

16  If  a  non-resident  alien  partner  fails  to  pay  the  tax  on  his 
share  of  the  profits,  the  partnership  might  l)e  held  liable  as  a 
resident  agent  having  custody  and  control  of  such  income,  but  the 
Treasury  Department  does  not  seem  so  far  to  have  required  any 


PARTNERSHIPS  111 

members  should  be  included  by  each  individual  partner 
receiving  the  same  in  his  annual  return  and  the  tax 
paid  thereon  as  required  by  law.  Both  normal  and 
supertaxes  must  be  paid,  except  as  noted  below.  When 
the  annual  profits  are  not  distributed  and  paid  to  the 
partners,  the  respective  interests  of  each  partner  in 
the  undistributed  profits  for  the  year  should  be  ascer- 
tained and  the  partners  entitled  thereto  should  include 
the  amount  of  their  respective  interests  in  their  annual 
returns  as  if  the  profits  had  been  distributed  and  paid 
to  them.*®  Such  undivided  annual  profits  of  partner- 
ships having  been  reported  by  the  individual  members 
thereof  and  the  tax  having  been  paid  thereon,  are  not 
again  taxable  to  the  partners  when  actually  distributed 
at  a  later  date.*''  The  distributive  interests  of  the  part- 
ners in  the  firm's  net  income  should  be  the  amount 
shown  by  the  books  when  closed  and  not  their  dis- 
tributive interests  in  the  amount  of  income  of  the  part- 
nership represented  by  actual  cash  receipts,  unless  the 
partnership  keeps  its  ]30oks  on  the  basis  of  cash  receipts 
and  disbursements.  Where  accounts'  receivable,  for 
instance,  are  entered  on  the  books  of  the  partnership 
as  income  and  the  amounts  thereof  are  treated  as  debts 
due  from  customers  or  clients,  the  partners'  returns 
are  required  to  be  based  on  the  total  sum  of  such 
accounts  receivable  and  not  on  the  amount  thereof  that 
has  actually  been  paid.*' 

action  to  be  taken  to  withhold  the  tax  at  the  time  of  payment. 
See  I.  T.  S.  1917,  H  2282. 

16  Koj?.  IV.i,  Art.  13. 

17  Reg.  -M,  Art.  14. 

18  Letter  from  Treasury  Department  dated  February  28,  1916; 
I.  T.  8.  1917,  11521. 


112  FEDERAL   INCOME  TAX 

Interest  on  National  Bonds.  A  partner  may  de- 
duet  from  his  net  distributive  interest  in  the  partner- 
ship a  proportionate  amount  of  the  income  received  by 
the  partnership  on  the  obligations  of  the  United  States, 
if  and  to  the  extent  that  it  is  provided  in  the  act 
authorizing  the  issue  of  such  obligations  that  they  are 
exempt  from  taxation.  This  provision  is  no  doubt 
intended  to  grant  the  same  exemption  to  partners  as 
is  granted  to  individuals  under  the  provision  of  Sec- 
tion 4  of  the  1916  Law  as  amended.  That  section,  how- 
ever, permits  the  deduction  of  interest  on  the  obligations 
of  the  United  States  whether  or  not  the  act  creating 
the  obligation  provides  that  the  obligation  shall  be 
exempt  from  tax,  except  in  the  case  of  obligations  issued 
after  September  1st,  1917.  Congress  undoubtedly  had 
in  mind  that  partners  should  be  allowed  to  deduct  the 
interest  on  obligations  of  the  United  States  issued  prior 
to  September  1st,  1917,  whether  or  not  the  act  authoriz- 
ing such  issue  specified  that  the  obligations  would  be 
exempt,  although  a  strict  construction  of  the  provision 
applying  to  partnerships  would  seem  to  prohibit  the 
deduction  in  all  cases  unless  the  authorizing  act  con- 
tained a  clause  exempting  the  interest.^® 

Interest  on  Bonds  op  the  States,  Possessions  and 
Political  Subdivisions.  The  interest  received  by  the 
partnership  on  the  obligations  of  a  state  or  any  political 
or  taxing  subdivision  thereof  and  upon  the  obligations 
of  the  possessions  of  the  United  States  may  be  deducted 
by  a  partner  in  proportion  to  his  share  of  the  total 
partnership  profits.  This  is  undoubtedly  intended  to 
giye  the  partner  the  benefit  of  the  same  exemption  as 

19  Act  of  September  8,  1916,  as  amended  by  Aet  of  October  3, 
1917,  §8,  Subdivision  (e). 


PARTNERSHIPS  113 

is  accorded  to  individuals  or  corporations  under  Section 
4  of  the  1916  Law,  although  that  section  refers  only  to 
"political  subdivisions  while  the  provision  relating  to 
partnerships  refers  to  "political  and  taxing  subdivi- 
sions." However,  political  subdivision  has  been  con- 
strued to  mean  any  subdivision  of  a  state  having  the 
power  to  levy  taxes  so  that  the  inclusion  of  the  phrase 
"taxing  subdivision"  does  not  seem  to  extend  any 
greater  exemption  to  partners  than  to  others.*® 

Dividends.  For  the  purpose  of  computing  the  normal 
tax  a  partner  is  allowed  a  credit  for  his  proportionate 
share  of  the  income  derived  by  the  partnership  from 
dividends.**  Although  this  provision  of  the  law  seems 
to  permit  a  credit  of  all  dividends,  it  is  undoubtedly 
intended  to  be  limited  to  dividends  on  the  stock  of 
corporations  subject  to  this  tax,  since  the  credit  to  be 
allowed  is  that  provided  by  section  5,  subdivision  (b), 
of  the  same  act  which  is  specifically  limited  to  such 
dividends.  The  rate  of  supertax  on  dividends  depends 
on  the  year  in  which  the  profits  were  earned  by  the  cor- 
porations.** 

Fiscal  Year.  A  partnership  has  the  same  privilege 
of  fixing  and  making  returns  upon  the  basis  of  its  own 
fiscal  year  as  is  accorded  to  corporations.  If  a  fiscal 
year  ended  during  1916  or  ends  during  a  subsequent 
calendar  year  for  which  there  is  a  rate  of  tax  different 
from  the  rate  of  the  preceding  calendar  year,  the  rate 
for  the  preceding  calendar  year  applies  or  shall  apply 

20  See  Chapter  29  on  Deduction  of  Interest. 

21  Act  of  September  8,  1916,  5  8,  Subdivision  (e),  as  amended 
by  Act  of  October  3,  1917. 

SS  See  Chapter  23. 
F.  I.  Tax.— 8 


114  FEDERAL   INCOME   TAX 

to  an  amount  of  each  partner's  share  of  such  partner- 
ship profits  equal  to  the  proportion  which  the  part  of 
such  fiscal  year  falling  within  such  preceding  calendar 
year  bears  to  the  full  fiscal  year  and  the  rate  for  the 
calendar  year  during  which  such  fiscal  year  ends  shall 
apply  to  the  remainder  of  such  profits.'^'  As  an  illus- 
tration of  this  provision,  assume  that  a  partnership 
closed  its  fiscal  year  on  June  30,  1916.  In  such  case 
after  each  partner  has  determined  the  share  of  the 
profits  to  be  reported  he  will  be  permitted  to  divide 
the  amount  by  two  (since  one-half  of  the  fiscal  year 
was  in  1916  and  one-half  in  1915)  and  pay  at  the  1915 
rates  on  one-half  and  at  the  1916  rates  on  the  other 
half.  Similarly  in  the  case  of  a  fiscal  year  ending  in 
1917  the  1916  rates  will  apply  to  such  proportion  of 
the  profits  as  the  part  of  the  fiscal  year  in  1916  bears 
to  the  whole  fiscal  year.  Prior  to  this  amendment  of 
the  statute  the  Treasury  Department  held  that  where  the 
fiscal  year  of  a  partnership  ended  at  any  time  other 
than  December  31st  the  total  profits  of  the  partnership 
were  required  to  be  reported  as  income  for  the  calendar 
year  in  which  the  fiscal  year  of  the  partnership  ended. 

Profits  Earned  Prior  to  March  1,  1913.  In  a  case 
arising  under  the  1913  Law  it  was  contended  that  where 
the  fiscal  year  of  a  partnership  ended  between  March  1, 
1913,  and  December  31st  of  the  same  year,  the  equitable 
method  would  be  to  apportion  the  profits  for  the  fiscal 
year  in  equal  monthly  instalments  and  allot  to  the 
period  preceding  March  1st  its  proper  proportion,  mak- 
ing the  partners  taxable  only  on  their  respective  shares 
ill   the  remainder.     The   court  held   that  the  plaintiff 

23  Act  of  September  8,  1916,  §8  (e),  as  amended  by  Act  of 
October  3,  1917. 


J'ARTNERSHIPS  115 

in  this  case  failed  to  show  that  profits  were  earned  by 
the  partnership  prior  to  March  1,  1913,  and  in  what 
sum,  and  in  the  absence  of  such  showing  the  court 
assumed  that  the  tax  was  legally  coHected.**  The  Treas- 
ury Department  held  under  the  1913  Law  that  the  entire 
amount  of  profits  accruing  to  a  partner  at  the  close  of 
the  fiscal  year  of  the  partnership  were  taxable  in  the 
calendar  year  in  which  the  fiscal  year  ended,**  although 
a  part  of  the  fiscal  year  may  have  covered  a  period 
prior  to  the  incidence  of  the  tax. 

Net  Losses  of  Paxtnership.  Where  the  books  of  a 
partnership  show  a  loss  for  a  year  in  accordance  with 
the  actual  facts,  the  respective  members  of  the  partner- 
ship should  include  as  a  deduction  such  amount  as  is 
charged  against  them  respectively,  as  the  loss  of  a  part- 
nership is  considered  to  be  a  loss  incurred  in  trade  by 
the  individual  members.  The  partner  may  deduct  the 
loss  whether  he  is  compelled  to  make  good  his  propor- 
tionate share  by  payment  of  money  to  the  partnership 
or  whether  the  loss  is  charged  against  profits  accrued 
to  his  account  in  preceding  years.**  If  the  loss  occurs 
in  a  fiscal  year  covering  a  period  in  which  there  is  a 
change  of  tax  rates  it  does  not  seem  that  the  loss  should 
be  pro-rated  although  the  income  if  any  would  be,  since 
a  loss  is  deductible  in  the  year  in  which  it  is  actually 
sustained.*'' 

Returns  by  Partnerships.  Partnerships  as  such  are 
not  required  to  render  returns  of  annual  net  income. 

24  Cohen  v.  Lowe,  234  Fed.  474. 
26  T.  D.  2090. 

26  Letter  from  Treasury  Department  dated  February  12,  191.1; 
r.  T.  S.  1917,  H  522. 

27  Sec  Chapter  31  on  Losses. 


116  FEDERAL  INCOME  TAX 

They  are,  however,  required  to  report  annually  the 
amount  of  tax  withheld  on  income  paid  to  non-resident 
aliens  under  the  provisions  of  law  requiring  collection 
at  the  source,**  and  to  file  such  annual  returns  as  are 
required  under  the  provisions  relating  to  information  at 
the  source.*® 

Special  Returns.  Any  partnership  when  requested 
by  the  Commissioner  of  Internal  Kevenue  or  any  col- 
lector is  required  by  law  to  make  a  correct  return  of 
its  earnings,  profits  and  income,  showing  the  gross 
income  and  the  deductions  and  credits  allowed  by  the 
law  and  the  names  and  addresses  of  the  individuals  who 
would  be  entitled  to  the  net  earnings,  profits  and  income 
if  distributed.  It  is  not  required  in  such  special  re- 
turns that  the  partnership  report  income  exempt  under 
Section  4  of  the  1916  Law.^® 

'■^ 

28  See  Chapter  41  on  Collection  at  the  Source. 

89  See  Chapter  40  on  Information  at  the  Source. 

30  Act  of  September  8,  1916,  §  8  (e) ;  Beg.  33,  Art.  12.  A 
special  return  from  partnerships  was  required  generally  in  1913, 
but  no  return  was  required  for  the  year  1914  or  for  subsequent 
years,  except  in  instances  where  it  was  specifically  requested  by 
the  Commissioner  of  Internal  Eevenue  or  a  collector. 


CHAPTER  11 

FOREIGN    PARTNERSHIPS 

The  law  expressly  mentions  foreign  partnerships  in 
only  one  provision  *  that  which  requires  the  withhold- 
ing of  the  tax  on  payments  of  income  from  interest  upon 
bonds  and  mortgages  or  deeds  of  trust  or  similar  obliga- 
tions of  domestic  or  other  resident  corporations,  to  non- 
resident alien  firms  and  copartnerships  not  engaged  in 
business  or  trade  within  the  United  States  and  not 
having  any  office  or  place  of  business  therein.  By  impli- 
cation, however,  the  income  of  a  foreign  partnership 
from  sources  within  the  United  States  is  taxable  in  the 
hands  of  the  non-resident  alien  partners,  to  the  extent 
included  in  the  distributable  share  of  each,  and  such  is 
the  ruling  of  the  Treasury  Department.*  If  the  partner 
is  a  citizen  or  resident  of  this  country,  he  is  of  course 
subject  to  tax  upon  his  entire  distributive  share  of  the 
profits  of  any  partnership  of  which  he  may  be  a  member. 

Definition.  No  definition  of  the  words  "alien  part- 
nership" appearing  in  the  section  of  the  law  referred 
to  in  the  preceding  paragraph,  is  to  be  found  in  the  law 
or  the  regulations.  The  law  refers  to  "non-resident 
alien  firms"  and  to  "non-resident  alien  copartnerships" 

1  Act  of  September  8,  1916,  as  amended,  S  13,  Subdirision  (e). 
8  Letter  from  Treasury  Department  dated  April  7,  1917;  I.  T.  8. 
1917,  1  2287. 

117 


118  '  FEDERAL   INCOME   TAX 

synonymously,  and  applies  the  term  without  regard  to 
whether  or  not  the  firm  or  copartnership  is  engaged  in 
business  or  trade  within  the  United  States  or  has  an 
office  or  place  of  business  in  this  country.  The  term 
apparently  has  reference  to  the  status  of  the  partners 
composing  the  firm,  and  in  this  respect  it  is  indefinite, 
as  a  firm  may  be  composed  of  non-resident  aliens  and 
resident  aliens  or  citizens.  For  the  sake  of  clearness 
in  discussing  the  subject  of  tliis  ichapter,  the  term 
"foreign  partnership"  as  used  herein  is  defined  as  a 
partnership  or  firm,  whether  composed  of  aliens  or 
citizens,  residents  or  non-residents,  which  has  its  prin- 
cipal place  of  business  in  a  foreign  country  and  directs 
all  or  the  principal  part  of  its  business  from  its  office 
outside  the  jurisdiction  of  the  United  States. 

Limited  Partnerships.  If  the  foreign  partnership  is 
one  of  the  kind  which,  if  it  were  domestic,  would  be 
treated  as  a  corporation  or  association,  it  seems  4hat  it 
should  report  its  net  income  and  pay  the  tax  according 
to  the  provisions  of  the  law  and  regulations  applicable 
to  foreign  corporations.  Having  done  so,  its  partners 
should  treat  their  net  distributive  shares  of  the  profits 
as  dividends.  Since  non-resident  alien  stockholders  of 
a  non-resident  foreign  corporation  are  not  taxable  to 
any  extent  on  the  dividends  of  such  corporation,  it 
would  follow  that  the  partners  of  a  non-resident  foreign 
partnership  or  association  which  is  required  by  the  regu- 
lations to  report  and  pay  the  tax  as  a  corporation,  would 
not  be  subject  to  any  tax  on  their  net  distributive 
shares  of  the  profits.  For  a  statement  of  the  rulings 
bearing  on  the  subject  of  partnerships  required  to  pay 
the  tax  in  the  manner  of  corporations  see  the  preceding 
chapter  on  partnerships. 


FOREIGN  PARTNERSHIPS  119 

General  Partnerships.  If  the  foreign  partnership  is 
d  general  partnership,  not  having  the  characteristics 
which  would  require  it  to  pay  the  tax  in  the  manner  of 
corporations,  it  is  not,  itself,  subject  to  the  tax  on 
income  derived  from  sources  within  this  country,  but 
each  of  its  individual  members  is  subject  to  the  tax  on 
such  part  of  his  distributive  share  of  the  partnership 
profits  as  is  composed  of  income  from  this  country.* 

Resident  Foreign  Partnerships.  A  foreign  part- 
nership which  is  engaged  in  business  or  trade  within  the 
United  States  and  has  an  office  or  place  of  business 
herein  is  a  resident  foreign  partnership.  Being  within 
the  jurisdiction  of  this  Government  the  tax  is  not^ 
withheld  at  the  source  upon  any  payments  made  to  it. 
For  the  purpose  of  establishing  its  identity  and  status 
a  form  has  been  provided  which  may  be  used  to  ac- 
company coupons  from  bearer  bonds  in  order  to  claim 
exemption  from  withholding  of  the  tax  at  the  source.* 

\on-Resident  Foreign  Partnerships.  A  non-resi- 
dent foreign  partnership  is  defined  as  a  foreign  part- 
nership which  does  not  have  any  office  or  place  of  busi- 
ness within  the  jurisdiction  of  the  United  States.  Such 
partnerships  are  subject  to  having  the  tax  withheld  on 
interest  from  investments  in  the  bonds  or  similiar  obli- 
gations   of    domestic    and    resident    corporations.*     A 

3  Letter  from  Treasury  Department  dated  December  6,  1916; 
I.  T.  S.  1917,  I  554. 

♦  Form  to  be  used  is  known  as  Form  1086;  T.  D.  2374. 

6  Act  of  September  8,  1916,  as  amended,  5  l;J,  Subdivision  (c). 
Although  this  provision,  as  amended,  has  been  held  not  to  require 
withholding  against  foreign  partnerships,  since  the  tax  specified 
therein  is  not  applicable  to  partnerships,  the  subject  is  discussed 
here  on  the   assumption   that  Congress   will  speedily  remedy  the 


i 

120  FEDERAL   INCOME   TAX 

strict  interpretation  of  the  provision  of  the  |ict  which 
requires  such  withholding  would  seem  to  make  it  apply 
only  in  cases  where  a  partnership  had  no  office  or  place 
of  business  in  this  country  and  the  members  of  the  part- 
nership are  non-resident  aliens.  The  Treasury  Depart- 
ment however  has  not  so  construed  the  language  of  the 
law  but  requires  withholding  regardless  of  the  status 
of  the  partners,  if  the  partnership  has  no  office  or  place 
of  business  here.® 

Collection  of  the  Tax  at  the  Source.  The  law  does 
not  require  the  withholding  of  the  tax  on  payments  of 
income  to  non-resident  foreign  partnerships,  except  in 
ihe  ease  of  payment  of  interest  on  bonds  and  similar 
obligations  of  domestic  corporations.''     Interest  on  the 

defect  in  the  statute  and  withholding  will  again  be  required  as 
formerly  under  this  provision. 

6  It  is  interesting  to  note  in  this  connection  that  immediately 
after  the  1913  Law  was  enacted  and  before  it  was  held  that  part- 
nerships were  not  subject  to  withholding,  the  Treasury  Depart- 
ment provided  for  the  use  of  partnerships  an  ownership  certificate 
which  required  a  statement  of  the  names  and  addresses  of  each 
of  the  partners.  No  such  disclosure  of  the  names  and  of  the 
partners  of  non-resident  foreign  partnerships  is  now  required, 
Which  indicates  that  the  Treasury  Department  does  not  consider 
the  individual  status  of  the  partners  to  be  essential  in  determining 
whether  or  not  withholding  is  necessary. 

1  The  language  of  Subdivision  (e)  of  Section  B  of  the  Act 
of  September  8,  1916,  as  amended,  is  ambiguous.  It  provides  that 
the  provisions  relating  to  withholding  of  the  tax  shall  be  made 
applicable  "to  the  tax  imposed  by  Subdivision  (a)  of  §10  upon 
incomes  derived  from  interest  upon  bonds  and  mprtgages  or  deeds 
of  trust  or  similar  obligations  of  domestic  or  other  resident  cor- 
porations *  *  *  by  non-resident  alien  firms."  No  tax,  as 
a  matter  of  fact,  is  imposed  upon  firms  or  partnerships  bv  Sub- 
division (a)  of  §  10,  and  consequently  it  has  been  ruled  that  no 
tax  need  be  withheld.     See  Note  5,  supra. 


FOREIGN  PARTNERSHIPS  121 

indebtedness  of  an  individual,  dividends  on  the  stock 
of  corporations  and  other  income  may  be  paid  to  a  non- 
resident foreign  partnership  without  deduction.  In 
no  case  is  withholding  required  on  payments  to  a  resi- 
dent foreign  partnership. 

Agents  for  Foreign  Paxtnerships.  A  resident  of  this 
country  may  for  purpose  of  the  income  tax  occupy  the 
position  of  an  agent  for  a  foreign  partnership  and  in 
connection  therewith  be  subject  to  the  duties  of  resident 
agents  as  indicated  in  the  chapter  on  that  subject.® 

Nominal  Stockholders.  If  a  foreign  partnership  is 
the  actual  owner  of  stock  of  domestic  or  resident 
corporations,  the  partners  thereof  are  subject  to  the 
supertax  (but  not  the  normal  tax)  to  the  same  extent 
as  other  individuals.  The  Income  Tax  Law  does  not 
require  withholding  of  the  tax  from  dividends,  whether 
paid  direct  to  a  non-resident  foreign  partnership  or 
through  a  nominal  stockholder.  "Where  the  non-resident 
foreign  partnership  is  the  actual  owner,  and  a  resident 
of  this  country  is  the  nominal  holder  of  the  stock, 
the  latter  should  proceed  as  indicated  in  the  chapter 
on  nominal  stockholders.®  If  a  non-resident  foreign 
partnership  is  a  nominal  stockholder,  a  certificate  dis- 
closing the  actual  ownership  should  be  executed  and 
forwarded  to  the  Collector  of  Internal  Revenue  at  Balti- 
more, Maryland,  in  order  that  the  members  of  the  part- 
nership may  avoid  any  liability  for  tax  because  of  the 
apparent  ownership  of  such  stock.*® 

«See  Chapter  6. 

9  See  Chapter  7. 

10  Telegram  from  Treasury  Department  dated  June  26,  1917; 
I.  T.  S.  1917,  12278. 


122  FEDERAL   INCOME   TAX 

Procedure  in  Collecting  Income.  A  resident  foreign 
partnership  in  collecting  income  from  interest  on  bonds 
should  make  use  of  the  form  which  certifies  that  it  is  a 
tirm  having  an  office  or  place  of  business  in  the  United 
States  and  therefore  not  subject  to  having  the  income 
tax  withheld  at  the  source.^^  A  non-resident  foreign 
partnership  in  collecting  similar  income  is  required  to 
use  the  same  certificate  as  is  used  by  non-resident  alien 
individuals.^'^  Upon  the  presentation  of  this  certifi- 
cate the  tax  is  required  to  be  withheld  by  the  debtor 
corporation  or  its  paying  agent.  In  collecting  any  other 
form  of  income  no  prescribed  certificate  is  necessary, 
but  the  partnership  may  be  called  upon  to  disclose  its 
name  and  location  for  the  purpose  of  supplying  the 
payor  of  the  income  with  the  information  which  he  must 
transmit  to  the  Government. 

Duty  in  Paying  Out  Income.  Kesident  foreign  part- 
nerships are  under  the  same  duty  in  paying  out  income 
to  others  as  are  domestic  partnerships ;  that  is,  they  are 
required  to  withhold  on  payments  made  from  the  office 
in  this  country  under  the  same  conditions  as  would 
require  domestic  partnerships  to  withhold.  They  are 
also  required  to  report  the  names  of  those  to  whom 
they  pay  fixed  or  determinable  income,  in  the  manner 
required  by  law  of  corporations,  partnerships  and  in- 
dividuals generally.^^* 

Extent  to  Which  Taxable.  Foreign  partnerships, 
unless  they  are  of  the  kind  taxable  as  corporations,  are 
not  taxable,  but  the  partners  are  required,  to  pay  the 
tax  in  all  cases  on  their  shares  of  the  profits,  gains  or 

11  The  official  title  of  this  form  is  Form  1086. 

18  This  ruling  is  temporarily  suspended.   See  page  473,  note  51. 

12a  See  Chapters  40  and  41. 


FOREIGN  PARTNERSHIPS  123 

income  arising  from  sources  within  the  United  States. 
Thus  in  the  case  of  resident  foreign  partnerships,  the 
income  from  the  business  transacted  in  the  United 
States  and  from  investments  in  this  country  is  taxable. 
In  the  case  of  a  non-resident  foreign  partnership,  income 
from  investments  in  this  country  and  gains  from  the 
buying  and  selling  of  property  of  any  kind  in  this  coun- 
try are  taxable.^'  Net  income  is  ascertained  undei*  the 
rules  applicable  to  non-resident  alien  individuals. 

Annual  Returns.  Neither  resident  nor  non-resident 
foreign  partnerships  are  required  to  file  returns  of  an- 
nual net  income.  Resident  foreign  partnerships  are 
required  to  file  annual  returns  reporting  the  amounts 
of  tax  withheld  at  the  source  and  also  annual  returns 
showing  the  names  and  addresses  of  those  to  whom 
fixed  and  determinable  income  has  been  paid  in  the 
same  manner  as  is  required  of  domestic  partnerships  and 
corporations  and  individuals.  Non-resident  foreign 
partnerships  are  under  no  duty  to  withhold  the  tax  on 
payments  to  others  and  under  no  duty  to  report  names 
of  persons  to  whom  payments  of  income  are  made. 

Special  Returns.  Both  resident  and  non-resident 
foreign  partnerships  may  be  called  upon  by  the  Commis- 
sioner of-Intemal  Revenue  to  file  special  returns  show- 
ing the  net  income  from  sources  within  this  country 
and  the  distributive  shares  of  the  partners  in  such 
income,  but  such  returns  need  not  be  filed  unless  the 
partnership  is  specifically  requested  to  do  so  by  the 
Commissioner  of  Internal  Revenue.^* 

13  Letter  from  Treasury  Department  dated  December  6,   191G: 
T.  T.  wS.  1917,11554. 
14 Letter  from  Treasury  Department  dated  December  6,   1916; 

T.  T.  R.  1917.  ir.'354. 


124  FEDERAL  INCOME  TAX 

Returns  by  Partners.  The  partners  of  foreign  part- 
nerships are  required  to  make  a  return  showing  their 
own  distributive  shares  of  the  income  of  the  partnership 
from  sources  in  this  country  on  the  same  form  as  is  used 
in  reporting  other  income.^*  If  a  partner  is  a  citizen 
or  resident  of  this  country  he  must,  of  course,  include  all 
of  his  income  from  the  foreign  partnership,  but  if  he  is 
a  non-resident  alien  only  so  much  as  has  been  derived 
from  sources  within  the  United  States.  In  making  his 
personal  return  the  partner  will  follow  the  procedure 
outlined  for  non-resident  aliens  or  the  procedure  out- 
lined for  citizens  and  residents,  as  the  case  may  be. 

16  Form  1040. 


.  CHAPTER  12 

CORPORATIONS 

Corporations  are  taxed  as  separate  entities  apart  from 
their  stockholders.  They  are  subject  only  to  the  normal 
tax  of  2%  under  the  1916  Law  and  4%  under  the 
1917  Law,  making  a  total  of  6%.  They  are  not  subject 
to  the  surtaxes.*  They  are  entitled  to  deduct  from 
their  gross  income  the  deductions  specified  in  the  law 
but  are  not  entitled  to  any  specific  exemption  such  as 
is  allowed  to  individuals.  Corporations  make  returns 
for  the  calendar  or  their  fiscal  years  as  they  may  elect. 
The  mere  existence  of  a  corporation  during  any  part 
of  the  year  is  sufficient  to  require  it  to  make  a 
return.*  The  mere  receipt  of  net  income  from  any  source 
makes  it  liable  for  the  tax.  Doing  business  is  not  a 
necessary  element  of  taxability.^  The  tax  is  an  income 
tax  and  not  an  excise  tax.* 

1  Reg.  33,  Art.  185. 
8T.  D.  2090. 

3  The  numerous  cases  under  the  1909  Law  holding  certain  cor- 
porations not  to  be  taxable  on  the  ground  that  they  were  not 
"doing  business"  have  no  application  to  the  present  income  tax 
laws. 

4  The  tax  assessed  on  corporations  for  the  months  of  January 
and  February,  1913,  under  the  1913  Law,  was  an  excise  tax  and 
not  an  income  tax  and,  therefore,  applied  only  to  corporations 
"doing  business,"  but  the  exemptions  and  deductions  to  which 
a  corporation  was  entitled  were  those  allowed  by  the  1913  Law, 
which  law  did  not  permit  the  deduction  of  dividends.  (Butterick 
Company  v.  U.  S.,  240  Fed.  539.) 

125 


126  FEDERAL.   INCOME    TAA 

Definition.  The  tax  is  imposed  upon  every  corpora- 
tion, joint  stock  company  or  association,  or  insurance 
company,  organized  in  the  United  States,  no  matter 
how  created  or  organized.  The  word  ''corporation" 
as  used  in  this  chapter  and  elsewhere  includes  joint 
stock  companies,  associations  and  insurance  companies. 

Joint  Stock  Companies.  There  seems  to  be  nb  con- 
stitutional or  legal  objection  to  including  joint  stock 
companies  in  the  same  category  with  corporations,^  A 
joint  stock  company  organized  under  the  New  York 
Joint  Stock  Association  Law  was  held,  under  the  1909 
Law,  to  be  practically  a  "corporation"  by  New  York 
law,  despite  the  absence  of  the  important  corporate 
attribute  of  limited  liability,  and  was  held  taxable  as 
such.* 

Associations.  Associations  are  treated  as  corpora- 
tions and  include  associates,  real  estate  trusts,  or  by 
whatever  name  known,  which  carry  on  or  do  business 
in  an  organized  capacity,  whether  organized  under  and 
pursuant  to  state  laws,  trust  agreements,  declarations 
of  trust  or  otherwise,  the  net  income  of  which,  if  any, 
is  distributed  among  the  members  or  other  owners  on 
the  basis  of  the  capital  stock  which  each  holds,  or,  where 
there  is  no  capital  stock,  on  the  basis  of  the  propor- 
tionate share  of  capital  which  each  has  invested  in  the 
business  or  property  of  the  organization.'' 

"Syndicates''  Are  Not  Corporations.  "Where  a 
block  of  securities  are  purchased  in  joint  account  by 

5  As  to  including  such  organizations  in  the  provisions  applicable 
to  corporations,  see  Spreckels  Sugar  Eefiniug  Co.  v.  McClain,  192 
TJ.  S.  397;  Flint  v.  Stone-Tracy  Co.,  220  U.  S.  107. 

6  Roberts  v.  Anderson,  226  Fed.  7. 

7  Reg.  33,  Art.  79. 


CORPORATIONS  127 

several  corporations,  partnerships  or  individuals  for  the 
purpose  of  disposing  of  them  to  the  public  through  the 
syndicate  managers,  the  only  obligation  of  the  members 
of  the  syndicate  being  to  take  and  pay  for  the  portion 
of  the  securities  not  disposed  of,  such  temporary  com- 
binations of  business  interests  are  neither  corporations, 
joint  stock  companies  or  associations,  nor  partnerships, 
within  the  meaning  of  the  income  tax  law  and  the  profits 
of  the  syndicate  are  not  taxable  in  the  hands  of  the 
sjTidicate.  The  several  members  pay  the  tax  on  their 
respective  shares  of  the  profit  of  the  transaction.' 

Trusts  Taxable  as  an  Association.  In  the  case  of  a 
trust  created  to  hold  certain  land  and  to  dispose  of  the 
same  and  distribute  the  proceeds  to  the  beneficiaries,  the 
title  stood  in  the  names  of  the  trustees  who  received 
and  distributed  moneys,  and  transacted  all  of  the  busi- 
ness connected  with  the  management  and  control  of  the 
trust  property.  The  pro-rata  interests  of  the  bene- 
ficiaries were  represented  by  beneficial  certificates  issued 
to  them  by  the  trustees.  These  certificates  could  be  trans- 
ferred if  the  transferee  executed  and  became  a  party  to 
the  original  declaration  of  trust  and  articles  of  agree- 
ment. The  purpose  of  the  trust  was  to  dispose  of  the 
land  from  time  to  time  and  pay  the  net  proceeds  over 
to  the  beneficiaries  and  the  trustees  had  no  power  to 
carry  on  any  other  business.  It  was  held  that  this  trust 
partook  of  the  character  of  an  association  and  was  sub- 
ject to  the  tax  as  an  entity.* 

Private  Banks.    Private  banks  which  have  the  form 
'  corporate  organizations,  elect  officers  and  a  board  of 

8  Letter  from  Trcisury  Department  dated  February  25,  1914 

9  I>ett«r  from  Treaaury  Department  dated  March  14,  1917. 


128  FEDERAL   INCOME  TAX 

managers,  have  a  distinctive  name  and  fixed  situs,  and 
distribute  their  net  earnings  upon  the  basis  of  the 
amount  of  capital  invested  by  the  members  or  owners, 
are  held  to  be  associations  within  the  meaning  of  the 
law  and  are  required  to  make  returns  and  pay  the  tax 
as  corporations.^®  The  net  earnings  of  such  organiza- 
tions are  considered  as  dividends.  If,  however,  the 
private  bank  is  owned  by  one  man,  that  is  considered  as 
evidence  that  the  bank  is  not  an  association.  And  if  a 
bank  does  not  have  the  formal  organization  noted  above 
but  transacts  business  in  the  names  of  the  individuals 
who  compose  the  firm,  the  bank  is  held  to  be  a  partner- 
ship.^^ 

Residence.  Domestic  corporations  are  considered  to 
be  residents  of  this  country  whether  or  not  their  prop- 
erty and  business  is  located  within  or  without  this 
country,  with  the  one  exception  noted  in  the  following 
paragraph.  No  consideration  is  given  by  the  law  or  the 
regulations  to  the  fact  that  domestic  corporations  may 
derive  all  of  their  income  from  sources  outside  of  the 
United  States.^*  The  question  assumes  importance  with 
respect  to  non-resident  aliens  deriving  income  from  the 
bonds  of  corporations  doing  business  entirely  outside 
of  this  country  and  the  question  of  residence  is  more 
fully  discussed  in  the  chapter  on  that  subject. 

10  T.  D.  2137. 

11  Mimeograph  letter  to  Collectors,  No.  1271. 

12  In  a  case  under  the  1909  Law  payment  of  the  tax  was 
refused,  the  corporation  alleging  under  advice  of  counsel  that 
because  its  business  was  transacted  in  a  foreign  country  and  it 
had  no  assets  in  this  country,  its  stockholders  living  in  the  foreign 
country  and  its  income  being  spent  and  invested  there,  it  was  not 
liable  for  the  tax  assessed.  The  Treasury  Department  proposed 
to  test  the  question,  but  after  suit  was  instituted  the  Company 


corporations  129 

Corporations  Doing  Business  in  the  Philippines  and 
Porto  Rico.  Corporations  doing  business  wholly  in 
these  possessions,  even  though  incorporated  in  the  United 
States,  are  held  to  be  resident  corporations  of  these  pos- 
sessions and  will  make  return  and  pay  the  income  tax 
to  the  collector  of  internal  revenue  having  jurisdiction 
therein.  If  a  corporation  is  resident  in  the  United  States 
but  doing  a  part  of  its  business  in  these  possessions,  it 
is  taxable  only  in  the  United  States.  If  a  corporation 
is  organized  under  the  laws  of  the  United  States  (i.  e 
the  federal  laws)  or  under  the  local  laws  of  the  posses- 
sions and  resident  in  the  possessions,  it  is  required  to 
pay  the  tax  in  the  Philippines  or  in  Porto  Rico,  as  the 
ease  may  be.*' 

Corporations  Formed  During  the  Year.  A  corpora- 
tion organized  during  the  year  is  required  to  make  a 
return  covering  that  portion  of  the  year  during  which 
it  was  engaged  in  business  or  had  an  income  accruing  to 
it.**  If  the  corporation  gives  proper  notice  of  its  selec- 
tion of  a  fiscal  year,  its  first  return  may  be  made  for  the 
period  beginning  with  the  date  of  incorporatioti  and  the 
close  of  such  year.  The  fact  that  a  new  corporation 
organized  in  the  year  has  transacted  no  business  does 
not  excuse  it  from  making  a  return.*'  Corporations  which 
have  applied  for  but  not  received  charters,  or  corpora- 
tions which  have  received  charters  but  have  not  perfected 
their  organizations,  transacted  no  business  and  had  no 
income  whatever  from  any  source,  may  upon  the  pres- 

reoeded   from   its   position   and  made  pajment   covering   the   tax 
and  penalties  and  the  action  was  discontinued.     (T.  D.  186.^.) 

13  T.  D.  2090. 

14  Reg.  33,  Art  84. 
16  T.  D.  2090. 

P.  I.  Tax.— 9 


130  FEDERAL   INCOME   TAX 

entation  of  these  facts  to  the  local' collector  be  relieved 
from  the  necessity  of  making  returns  so  long  as  they  re- 
main in  this  unorganized  condition.^^  When  a  distinct 
new  corporation  is  organized  to  take  over  the  property 
of  an  old  corporation,  both  corporations  will  be  required 
to  make  returns  covering  the  periods  of  the  year  during 
which  they  were  each  respectively  in  charge  of  the 
business.*'' 

Corporations  Merging  During  the  Year.  In  case  of  a 
merger  or  consolidation  of  two  or  more  corporations 
during  the  year,  each  corporation  is  required  to  make  a 
return  of  the  income  received  during  tlie  year  prior  to 
the  date  of  merger  and  consolidation.  If  each  or  any 
of  the  component  corporations  subsequent  to  the  con- 
solidation collects  prior  existing  debts  it  must  include  in 
its  separate  return  all  of  such  collected  debts.*' 

Change  of  Name.  The  mere  change  of  name  does  not 
constitute  a  new  corporation.  The  returns  should  be 
made  in  the  name  the  corporation  bears  at  the  end  of 
the  year,  with  a  notation  to  the  effect  that  the  name  has 
been  changed,  giving  both  the  old  and  new  names.*® 

Corporations  Liquidating  During  the  Year.  A  cor- 
poration going  into  liquidation  during  any  tax  period 
may  at  the  time  of  such  liquidation  prepare  a  "final 
return"  covering  the  income  received  or  accrued  to  it 
during  the  fractional  part  of  the  fiscal  or  calendar  year 
during  which  it  was  engaged  in  business,  and  imme- 

16  T.  D.  2152. 

17  T.  D.  2137. 

18  T.  D.  1675. 

•19  T.  D.  21.^7.  * 


CX>RP0KAT10NS  131 

diately  file  it  with  the  local  collector.*®  Where  a  cor- 
poration, by  affidavit  or  otherwise,  has  clearly  estab- 
lished the  fact  and  satisfied  the  collector  of  internal 
revenue  that  it  is  defunct,  dissolved  or  obsolete  and  is 
no  longer  carrying  on  business  and  has  no  property  or 
income,  returns  will  not  be  required  after  such  condition 
has  been  clearly  established.-  Only  one  showing  of  this 
character  is  required,  unless  it  appears  later  that  the 
corporation  has  income  within  the  meaning  of  the 
law." 

Llvbility  for  Tax  After  Dissolution.  Corporations 
in  receipt  of  income  during  any  part  of  the  taxable  yeaf, 
but  dissolved  prior  to  the  end  of  the  year,  are  liable  for 
the  tax  on  such  income.  A  corporation  dissolved  in  1917, 
prior  to  the  passage  of  the  1917  Law  is  liable  thereunder, 
since  the  law  is  retroactive  to  January  1,  1917.*^"  The 
assets  are  subject  to  a  lien  for  the  payment  of  taxes  pro- 
vided the  corporation  has  not  been  dissolved,  and  all  its 
assets  distributed,  prior  to  the  time  the  list  of  assess- 
ments get  into  the  hands  of  the  collector. 

Collection  of  T^vx  prom  Assets.  Section  3186  of 
the  Revised  Statutes,  as  amended,  provides  generally 
with  reference  to  internal  revenue  taxes  that  "If  any 
person  liable  to  pay  any  tax  neglects  or  refuses  to  pay 

20  Reg.  33,  Art.  85 ;  T.  D.  2090.  It  was  held  under  the  Corpo- 
ration Excise  Tax  Law  of  1909  that  a  corporation  could  not  evado 
lialiility  for  the  tax  by  dissolving  before  the  time  when  it  was 
rt-quired  to  make  a  return.  United  States  v.  General  Inspection 
&  Loading  Company,  192  Fed.  223. 

81  T.  D.  2137. 

81a  Letter  from  Treasury  Department  dated  November  17, 
1917;   I.  T.  8.   1917,  112496.     Brady  v.  .\nder8on,  240  Fed.  665. 


132  PEDEKAL    INCOME   TAX 

the  same  after  demand,  the  amount  shall  be  a  lien  in 
favor  of  the  United  States  from  the  time  when  the  assess- 
ment list  was  received  by  the  collector,  except  when 
otherwise  provided,  until  paid,  with  the  interest,  penal- 
ties and  costs  that  may  accrue  in  addition  thereto,  upon 
all  property  and  rights  belonging  to  such  person."  The 
1916  Law  provides  (Sec.  22)  that  "all  administrative, 
special  and  general  provisions  of  law,  including  the  laws 
in  relation  to  assessment,  remission,  collection  and  re- 
fund of  internal  revenue  taxes  not  heretofore  specifically 
repealed  and  not  inconsistent  with  the  provisions  of  this 
title,  are  hereby  extended  and  made  applicable  to  all 
the  provisions  of  this  title  and  to  the  tax  herein  im- 
posed."  Under  the  Income  Tax  Law  it  is  the  duty  of 
the  Commissioner  of  Internal  Kevenue  to  send  to  each 
collector  a  list  of  the  companies  liable  for  the  tax  in  his 
district  showing  the.  amounts  for  which  they  are  liable 
within  such  time  that  the  collector  may  give  the  required 
notice  of  assessment  on  or  before  the  first  day  of  June, 
and  upon  such  lists  the  collections  are  made.  Under  the 
provisions  of  Section  3186  above  quoted  the  lien  is  fixed 
upon  the  assets  of  the  corporation  when  this  list  comes 
into  the  collector's  hands.  Therefore,  if  the  corporation 
has  distributed  all  of  its  assets  and  become  dissolved 
in  the  manner  provided  by  law,  prior  to  that  time  tliere 
is  nothing  upon  which  the  lien  can  attach,  and  conse- 
quently no  lien  exists  to  secure  the  payment  of  the  tax 
which  may  be  due  from  the  corporation.  Notwithstand- 
ing this  particular  provision  for  collecting  the  tax,  the 
remedy  is  not  exclusive,  and  the  Government  may  resort 
to  the  common  law  method  of  collecting  the  same.***  The 
dissolution  of  a  corporation  does  not  extinguish  its  lia- 

28  Dollar  Savings  Bank  v.  IT.  S.,  19  Wall  227. 


CHJBPOBATIONS  133 

bilities  and  through  the  courts  of  equity  creditors  may 
pursue  its  assets  into  the  hands  of  any  person  who  is 
not  a  h(yna  fide  purdtaser.  The  sale  of  the  entire  capital 
stock  of  a  corporation  and  the  distribution  of  the  pro- 
ceeds of  the  sale  among  the  stockholders  will  not  defeat 
or  impair  the  remedy  of  creditors,  if  any  debts  remain 
unpaid,  as  the  creditors  in  that  event  may  pursue  the 
proceeds  of  the  sale  in  the  hands  of  the  respective 
sto«kholders  and  compel  each  one  to  contribute  prorata 
toward  the  payment  of  the  debts  to  the  extent  of  the 
moneys  received  on  the  distribution.^  This  remedy  is 
open  to  the  Government  in  the  same  manner  as  it  is 
to  any  other  creditor.**  But  if  a  corporation  has  gone 
out  of  biLsiness  leaving  assets  which  have  been  distributed 
among  the  stockholders,  such  assets  are  not  availabh* 
for  collection  of  the  penalty  for  failure  to  file  returns.** 

Income  Subject  to  Tax.  Corporations  are  subject  to 
tax  on  income  received  from  all  sources,  except  income 
exempt  from  the  law  under  the  provisions  of  Section  4 
of  the  1916  Law,  as  amended,  such  as  the  interest  upon 
obligations  of  a  state  or  any  political  subdivision  thereof 
or  upon  the  obligations  of  the  United  States  or  its  posses- 
sions or  securities  issued  under  the  provisions  of  the 
Federal  Farm  Loan  Act.  It  would  seem  also  that  under 
the  present  income  tax  laws  a  corporation  is  exempt 
from   tax  on  the  value  of  property  acquired  by  gift 

23  Railroad  Company  v.   Howard,  7  Wall  ,192. 

84  28  Op.  Atty.  Gen.  241.  In  the  case  of  U.  S.  v.  General 
Inspei'tion  and  Loading;  Company  (192  Fed.  22'A,  204  Fed.  G.")?  i 
'iiidgrment  was  entered  for  tax,  penalty  and  interest  under  the 
1909  Law,  notwithstanding  the  corporation  had  heen  previously 
dissolved. 

26  T.  D.  1852. 


134  b'EDERALr   INCOME   TAX 

although  it  was  held  under  the  1913  Law  that  the  exemp- 
tion of  gifts  did  not  apply  to  corporations.  There  is 
this  important  difference  in  the  provisions  of  the  two 
laws  relating  to  gifts  namely,  that  the  1913  Law  provided 
for  the  exemption  of  gifts  under  a  provision  applicable 
to  individuals  only  and  made  no  mention  of  such  exemp- 
tion in  the  provisions  applicable  to  corporations,  while 
the  1916  Law  provides  for  the  exemption  of  the  value  of 
gifts  in  a  section  which  applies  with  equal  force  to  cor- 
porations and  individuals.^*  A  corporation  reports  all 
of  its  net  income  to  the  collector  of  the  district  in  which 
its  principal  place  of  business  is  located  and  pays  the 
tax  in  the  same  district  regardless  of  the  fact  that  it 
may  be  doing  business  in  other  districts  in  the  states, 
territories,  or  possessions  of  the  United  States.  Where 
a  corporation  is  engaged  in  carrying  on  more  than 
one  class  of  business  the  gross  income  derived  from  the 
different  classes  is  ascertained  according  to  the  rules 
applicable  thereto  and  the  gross  income  of  all  classes 
of  business  in  which  the  corporation  is  engaged  is  taken 
to  be  the  gross  income  of  the  corporation.  Thus  the 
gross  income  of  manufacturing  companies  consists  of 
the  total  sales  of  manufactured  goods  during  the  year, 
increased  or  decreased  by  the  gain  or  loss  as  shown  by 
the  inventories  of  finished  and  unfinished  products,  raw 
material,  etc.,  at  the  beginning  and  end  of  the  year;  and 
mercantile  companies  proceed  similarly  in  determining 
their  gross  income  by  inventory,  adding  in  each  case  the 
income  from  all  other  sources.^''  Insurance  companies 
determine  their  net  income  by  special  provisions  relating 
to  that  class  of  business,  which  provisions  are  discussed 

26  Compare    §4,   Act  of  Septemher  8,   1916,   nnd  1TB.   Act  of 
October  3,  1913. 

27  Reg.  33,  Arts.  104  and  105. 


CORPORATIONS  135 

in  the  following  chapter.  The  general  provisions  as  to 
iiu'oiue  applicable  both  to  corporations  and  individuals 
are  discussed  in  succeeding  chapters  on  income**  and 
only  the  special  provisions  applicable  to  corporations  are 
referred  to  in  this  chapter.  All  receipts  by  a  corporation 
are  not  income  as  is  indicated  in  the  following  para- 
graph and  also  in  the  chapters  on  income. 

Sale  op  Capital  Stock.  The  amount  received  by  a 
corporation  in  exchange  for  its  capital  stock  is  held  to 
l)e  capital  of  the  corporation,  whether  or  not  the  amount 
received  is  equal  to  or  greater  than  the  par  value.  Such 
transactions  are  purely  capital  transactions  and  the  in- 
come is  not  increased  by  reason  of  the  sale  of  the  stock 
at  a  price  greater  than  its  par  value.*® 

Deductions  from  Gross  Income  Allowed  by  Law. 
The  statute  specifies  particularly  the  deductions  which 
may  be  made  from  gross  income  in  ascertaining  the  net 
income  subject  to  tax.  These  deductions  are  four  in 
number  as  specified  in  Section  12  of  the  1916  law.  The 
general  discussion  of  the  deductions  allowed  to  taxpayers 
is  found  in  the  chapters  on  that  subject.*®  In  this  chap- 
ter reference  is  made  to  those  provisions  having  applica- 
tion only  to  corporations 

Ordinary  and  Necessary  Expensesf  A  corporation 
is  allowed  to  deduct  all  the  ordinary  and  necessary  ex- 
penses paid  within  the  j^ar  in  the  maintenance  and 
operation  of  its  business  and  properties,  including 
rentals  or  other  payments   required   to  be  made  as  a 

88  See  Chapters  \6  et  aeq. 

99  T.  D.  2090. 

30  See   Clmpters   27    et  aeq. 


136  FEDERAL   INCOME   TAX 

condition  to  the  continued  use  or  possession  of  property 
to  which  the  corporation  has  not  taken  or  is  not  taking 
title,  or  in  which  it  has  no  equity.  It  will  be  noted  that 
the  expenses  permitted  by  this  provision  of  law  are  only 
the  ordinary  and  necessary  expenses.  Extraordinary  ex- 
penses are  not  deductible  under  this  head  and  if  they 
do  not  fall  under  one  of  the  other  deductions  allowed  by 
law  may  not  be  permitted  in  computing  net  income,  al- 
though they  may  be  deductions  recognized  in  aecouiiting 
practice  as  a  proper  charge  against  the  income  for  the 
year. 

Organization  Expenses.  The  Treasury  Department 
holds  that  organization  expenses  of  corporations  such  as 
attorneys'  and  accountants'  fees  together  with  fees  paid 
to  the  state  authorities  prior  to  or  coincident  with  the 
securing  of  a  charter  and  the  incorporation  of  a  com- 
pany constitute  a  capital  investment,  such  assets  being 
offset  by  the  asset  value  of  the  corporate  franchise,  an 
intangible  asset  of  a  somewhat  permanent  character  and 
in  many  instances  of  substantial  value.  Such  expenses 
incident  to  and  connected  with  the  incorporation  and 
organization  of  the  company  are  Hot  "ordinary  and 
necessary  expenses  of  maintenance  and  operation ' '  which 
are  the  only  ''expenses"  authorized  by  the  law  to  be 
deducted.^* 

Payments  in  Lieu  of  Rent.  This  item  includes  all 
royalties  or  other  charges,  including  any  interest  pay 
ment  which  the  corporation  is  required  to  make  for  the 

31  T.  D.  2499.  This  ruling  is  not  in  accordance  with  account- 
ing practice,  which  recognizes  the  propriety  of  charging  off 
organization  exjienses  against  income  over  a  period  of  four  or 
five  years. 


00BP0RATI0N8  137 

right  to  use  and  possess  property  in  which  it  has  no  con- 
trol, interest  or  equity. 

Losses.  The  second  deduction  specified  in  the  law 
permits  an  allowance  for  all  losses  actually  sustained 
and  charged  off  within  the  year  and  not  compensated  by 
insurance  or  otherwise,  including  a  reasonable  allowance 
for  the  exhaustion,  wear  and  tear  of  property  arising  out 
of  its  use  or  employment  in  the  business  or  trade  and  a 
reasonable  allowance  for  reduction  in  flow  of  oil  and  gas 
wells  and  depletion  of  mining  deposits.  This  allowance 
is  similar  to  the  allowance  permitted  to  individuals  and 
is  discussed  in  the  chapters  on  deduction.**  One  ruling 
on  losses,  having  application  only  to  corporations,  is 
given  below. 

Redemption  op  Preferred  Stock,  Where  a  corpora- 
tion issued  preferred  stock  at  par  redeemable  at  110,  the 
difference  appearing  on  the  lK)oks  of  the  corporation  as 
a  reduction  of  undivided  profits,  the  transaction  has  been 
held  to  be  "a  capital  transaction  in  which  there  could  be 
no  gain  or  loss  to  the  corporation  and,  therefore,  the 
difference  between  the  selling  price  of  the  stock  and  the 
price  at  which  it  was  redeemed  could  not  be  deducted  as 
a  loss.*' 

Insurance  Companies,  The  special  provisions  allow- 
ing deductions  by  insurance  companies  under  this  head- 
ing are  treated  in  the  following  chapter. 

Interest.  There  may  be  deducted,  in  the  case  of  cor- 
porations, the  amount  of  interest  paid  within  the  year 

seSoe  Chapters  31  to  34. 

33  Loiter  from  Treasury  Department,  dated  April  11,  1917: 
I.  T.  S.  1917,  112208.  The  ruling  is  different  as  to  redemption 
of  bonds  sold  at  a  discount.     See  Chapter  31. 


138  b'EDEKAL,   INCOME   TAX 

on  its  indebtedness  (except  indebtedness  incurred  for 
the  purchase  of  obligations  or  securities,  the  interest 
upon  which  is  exempt  from  taxation  as  income  under  the 
law)  to  an  amount  of  such  indebtedness  not  in  excess  of 
the  sum  of  (a)  the  entire  amount  of  the  paid  up  capital 
stpck  outstanding  at  the  close  of  the  year,  or,  if  no  capital 
stock,  the  entire  amount  of  capital  employed  in  the  busi- 
ness at  the  close  of  the  year,  and  (b)  one-half  of  its  in- 
terest-bearing indebtedness  then  outstanding.  In  the  case 
of  interest  paid  on  indebtedness  wholly  secured  by  prop- 
erty collateral  tangible  or  intangible,  the  subject  of  sale 
or  hypothecation  in  the  ordinary  business  of  the  corpora- 
tion, as  a  dealer  only  in  the  property  constituting  such 
collateral,  or  in  loaning  the  funds  thereby  procured,  the 
total  interest  may  be  deducted  as  a  part  of  the  expense 
of  doing  business,  on  an  amount  of  such  indebtedness 
not  in  excess  of  the  actual  value  of  such  property  collat- 
eral. Banks  may  also  deduct  all  interest  paid  within  the 
year  on  deposits,  or  on  moneys  received  for  investment 
and  secured  by  interest-bearing  certificates  of  indebted- 
ness.^* 

The  meaning  of  the  exception  as  to  indebtedness  in- 
curred for  the  purchase  of  obligations  or  securities,  the 
interest  upon  which  is  exempt  from  taxation  as  income, 
is  discussed  in  a  following  chapter  on  deductions.  The 
arbitrary  limitation  upon  the  amount  of  interest  on  or- 
dinary indebtedness,  having  peculiar  application  to  cor- 
porations, is  discussed  in  the  following  paragraphs. 

Reason  for  the  Limitation.  This  arbitrary  limita- 
tion upon  the  amount  of  interest  which  may  be  deducted 
by  a  corporation  is  a  survival  of  a  provision  of  the  1909 
Tiaw.  which  imposed  an  excise  tax  on  corporations  meas- 

34  Act.  of  September  8,  1916,  §  12. 


CORPORATIONS  139 

ured  by  tlie  amount  of  inuome.  in  eoustruiiig  the  1909 
Law  the  Supreme  Court  held  that  it  was  uot  iii  any 
proper  sense  an  income  tax  law,  nor  intended  as  such, 
but  was  an  excise  tax  upon  the  conduct  of  business  in  a 
corporate  capacity,  the  tax  being  measured  by  reference 
to  the  income  in  a  nmnner  prescribed  by  the  act  itself.  In 
limiting  the  amount  of  interest  which  a  corporation  could 
deduct  under  that  law  Congress  evidently  had  in  view 
the  fact  that  some  corporations  carry  a  current  indebted- 
ness exceeding  the  amount  of  paid  up  capital  stock  and 
with  respect  to  such  corporations  intended  to  limit  the 
interest  deduction  to  so  much  of  the  indebtedness  as  did 
not  exceed  the  capital.  It  appears  that  Congress  deemed 
that  where  the  indebtedness  exceeded  that  capital  it 
should  no  longer  be  treated  as  an  incident,  but  should 
be  considered  as  a  principal  object  of  the  corporate 
activities,  and  that  the  operations  of  such  a  corporation 
were  conducted  more  for  the  benefit  of  the  creditors  than 
of  the  stockholdei's.  There  is  no  question  of  the  power 
of  Congress  to  adopt  such  a  basis  of  distinction.**  While 
the  reason  for  such  arbitrary  limitation  was  excellent  in 
the  case  of  a  tax  such  as  that  imposed  by  the  1909  Law, 
which  could  otherwise  have  been  avoided  by  the  conver- 
sion of  capital  into  indebtedness,  the  reason  applies  with 
much  less  force  to  the  present  law  where  the  income 
which  is  not  taxed  to  the  corporation  becomes  taxable 
to  the  bondholder.  To  the  extent,  therefore,  that  a  cor- 
poration is  not  permitted  to  deduct  all  of  the  interest 
paid  on  its  indebtedness  such  interest  is  subject  to  tax 
both  to  the  corporation  and  to  the  bondholder.** 

36  Anderson  v.  Forty-two  Broadway  Company,  239  U.  S.  69, 
loversing  213  Fed.  777. 

36  This  does  not  tlirow  a  double  burden  on  the  bondholder,  but 
it  throws  an  extra  burden  on  the  stockholders  of  the  corporation 


140  FEDERAL   INCOME   TAX 

Interest-Bearing  Indebtedness.  The  interest-bear- 
ing indebtedness  referred  to  in  this  provision  of  the  law 
does  not  include  preferred  capital  stock ;  interest  or 
dividends  paid  upon  such  stock  is  not  deductible  from 
gross  income.^'''  It  does  not  include  indebtedness  secured 
by  collateral  subject  to  sale,  which  is  referred  to  in  a 
following  paragraph.  Under  the  1909  Law,  if  a  corpora- 
tion took  title  to  real  property  subject  to  a  mortgage  but 
did  not  assume  the  indebtedness  secured  thereby,  the  in- 
terest could  be  deducted  in  full,  as  this  would  not  be  a 
payment  by  the  corporation  owning  the  property  sub- 
ject to  such  lien  on  its  own  indebtedness,  because  the 
indebtedness  was  not  its  bonded  or  other  indebtedness, 
but  an  indebtedness  created  by  a  third  party  and  charged 
as  a  lien  upon  the  land  acquired,  subject  thereto,  by  the 
purchasing  corporation.^^  But  the  1916  Law  does  not 
permit  of  this  construction  since  it  provides  that  "pay- 
ments required  to  be  made  as  a  condition  to  the  con- 
tinued use  or  possession  of  property,"  as  the  phrase  ap- 
peared in  the  1909  and  1913  Laws,  must  be  with  respect 
to  property  "to  which  the  corporation  has  not  taken  or 

who  are  deprived  of  earnings  to  the  extent  that  interest  paid  to 
bondholders  is  taxed  to  the  corporation.  The  arbitrary  limitation 
results  in  the  creation  of  a  fictitious  income  on  which  the  corpo- 
ration is  taxed,  and  since  at  the  present  time  such  fictitious  income 
not  only  is  subject  to  a  heavy  income  tax  but  enters  very  mate- 
rially into  the  computation  of  an  extraordinarily  heavy  excess 
profits  tax,  the  provision  operates  with  rank  injustice  in  the  case 
of  corporations  which  have  an  indebtedness  greatly  in  excess  of 
their  capital  stock.  In  fact,  it  seems  inevitable  that  real  estate 
corporations  such  as  the  Forty-two  Broadway  Company,  which 
raised  the  question  under  the  1909  Law,  will,  under  the  present 
income  tax  and  excess  profits  tax  laws,  incur  such  heavy  tax 
burdens  as  to  place  them  in  grave  danger  of  insolvency. 

37  Act  of  September  8,  1916,  §  12. 

88  28  Op.  Atty.  Gen.  198. 


CORPORATIONS  141 

is  not  taking  title,  or  in  which  it  has  no  equity. ' '  Where 
a  coi*poration  purchases  property  encumbered  by  a  mort- 
gage or  other  lien  and  the  amount  thereof  is  a  part  of 
and  included  in  the  purchase  price,  upon  the  payment 
of  which  the  titU;  vests  absolute  in  the  purchaser,  the 
purchaser  assumes  the  indebtedness  on  the  property  thus 
purchased  and  interest  thereon  partakes  in  no  degree 
of  the  nature  of  rental  or  franchise  charges  and  its  de- 
duction is  limited  by  the  provisions  of  law.^®  If  a  cor- 
poration has  an  equity  in  or  is  purchasing  for  its  own 
use  the  real  estate  upon  which  a  mortgage  is  a  prior 
lien  and  the  corporation  assumes  the  payment  of  interest, 
the  indebtedness  will  be  held  to  be  indebtedness  of  the 
corporation  within  the  meaning  of  the  law  and  interest 
paid  on  such  mortgage  will  l>e  deductible  only  within 
the  limit  fixed  by  the  law.*®  Where  a  corporation  is 
engaged  in  a  business  by  which  it  both  receives  and 
pays  out  interest  the  full  amount  received  must  be  in- 
eluded  as  gross  income  and  only  the  amount  within  the 
limit  fixed  by  law  may  be  deducted.** 

Indebtedness  Bearing  Different  Rates  op  Interest. 
Where  a  corporation  has  several  classes  of  indebtedness 
bearing  different  rates  of  interest  and  the  aggregate 
amount  of  indebtedness  exceeds  the  limit  allowed  by  law, 
the  indebtedness  bearing  the  highest  rate  may  be  first 
considered  in  computing  the  interest  deduction,  and  the 
balance,  if  any,  will  be  computed  on  the  indebtedness 
bearing  the  next  lower  rate  and  so  on  until  the  interest 
on  the  maximum  principal  allowed  has  been  computed.** 

39  T.  D.  1865. 
40Rog.  33,  Art.   148. 

41  Altheimer  &  Rawlings  Investment  Co.  v.  Allen,  T.  D.  2441 ; 
Middlesex  Bankinjr  Co.  v.  Eaton,  233  Fed.  87. 
4>Reg.  33,  Art.  151. 


142  federal  income  tax 

Indebtedness  Outstanding  at  Close  op  the  Year. 
If  no  indebtedness  is  outstanding  at  the  close  of  the 
year,  the  maximum  deduction  allowable  on  account  of 
interest  paid  will  be  measured  by  an  amount  of  in- 
debtedness not  exceeding  at  any  time  within  the  year  the 
entire  paid  up  capital  stock  outstanding  at  the  close  of 
the  year ;  that  is  in  such  case  the  capital  stock  outstand- 
ing at  the  close  of  the  year  measures  the  highest  amount 
of  indebtedness  upon  which  deductible  interest  can  be 
computed.*^ 

Paid  Up  Capital  Stock  Outstanding  at  the  Close 
of  the  Year.  This  phrase  means  the  par  value  of  shares 
issued  as  reported  in  Item  1  of  the  return  form  and  does 
not  include  the  surplus  carried  by  the  corporation.  The 
full  amount  of  stock  represented  by  the  par  value  of 
the  shares  issued  is  to  be  regarded  as  the  paid  up  capital 
stock,  except  when  such  stock  is  assessable  on  account  of 
deferred  payments,  or  payable  in  instalments,  in  which 
case  the  amount  actually  paid  on  such  shares  constitutes 
the  actual  paid  up  capital  stock.**  Where  the  capital 
stock  of  the  corporation  is  issued  without  par  or  nominal 
value,  the  law  provides  that  the  amount  of  capital  stock 
as  represented  by  such  shares  will  be  the  amount  of  cash 
or  its  equivalent  paid  or  transferred  to  the  corporation 
as  a  consideration  for  such  shares.  If  such  shares  have 
been  issued  as  a  bonus  in  connection  with  shares  of 
preferred  stock,  in  that  event,  the  par  value  of  the  pre- 
ferred stock  will  be  the  limit  which  may  be  claimed  as 
paid  up  capital  stock.  If  both  common  and  preferred 
are  issued  for  cash  or  other  equivalent  consideration,  the 
amount  will  be  the  par  value  of  the  preferred  stock  plus 

43  T.  D.  I960. 

44  T.  D.  2090;    Reg.  33,  Art.  95. 


CORPORATIONS  143 

the  amount  actually  paid  in  on  the  shares  issued  without 
par  value.**  Neither  in  the  ease  of  stock  issued  with  a 
par  value  nor  in  the  case  of  stock  issued  without  par  value 
can  the  amount  of  paid  up  capital  stock  be  increased 
except  as  new  capital  is  paid  in  and  for  which  additional 
shares  are  issued.*®  ^ 

Interest  Paid  by  Banks  on  Deposits.  In  the  case  of 
a  bank,  banking  association,  loan  or  trust  company,  the 
interest  paid  on  deposits  or  on  moneys  received  for  in- 
vestment and  secured  by  interest-bearing  certificates  of 
indebtedness  issued  by  such  bank,  banking  association, 
loan  or  trust  company,  may  be  deducted  in  full.  Where 
a  corporation,  chartered  as  a  bank,  was  engaged  in  the 
business  of  selling  debenture  bonds  and  guaranteed  real 
estate  securities,  by  a  method  by  which  it  both  paid  and 
received  interest,  it  was  held  that  the  interest  paid  out 
could  not  be  deducted  in  full  as  interest  paid  on  de- 
posits, the  transaction  in  no  way  being  a  banking  trans- 
action.*'' It  seems  that  such  interest  can  now  be  deducted 
as  interest  paid  on  indebtedness  secured  by  collateral. 

Interest  on  Indebtedness  Secured  by  Collateral. 
Such  interest  may  be  deducted  without  limit  provided 
(a)  the  indebtedness  is  wholly  secured  by  property  col- 
lateral, tangible  or  intangible,  (b)  such  collateral  is  the 
subject  of  sale  or  hypothecation  in  the  ordinary  business 
of  the  corporation  as  a  dealer  in  such  property  or  in 

*6  Letter  from  Treasury  Department  dated  January  l.X,  1916: 
I.  T.  S.  1917,  fl462. 

*«  Letter  from  Treasury  Department  dated  January  i;»,  191fi; 
I.  T.  S.  1917,  111463. 

*7  Middlesex  Banking  Company  v.  Eaton.  2.S.^  Fed.  87. 


144  FEDERAL   INCOME   TAX 

loaning  the  funds  thereby  procured  and  (c)  that  the 
indebtedness  does  not  exceed  the  actual  value  of  such 
property  collateral.  Such  interest  is  deductible  not  as 
interest  paid,  but  as  an  expense  of  doing  business.  The 
interest  deducted  under  this  provision  of  the  law  must 
be  stated  separately  in  the  return  of  annual  net  income 
and  must  be  segregated  from  indebtedness  not  so 
secured.  Failure  to  segregate  the  two  forms  of  indebted- 
ness will  result  in  a  suspension  or  disallowance  of  the 
amount  claimed.** 

Collateral  the  Subject  op  S^vle.  This  phrase  as 
used  in  the  law  refers  to  tangible  or  intangible  property 
bound  for  the  performance  of  certain  covenants  or  pay- 
ment of  certain  obligations.  Real  estate  owned  and 
mortgaged  by  corporations  organized  for  and  engaged 
in  the  business  of  buying,  selling  and  dealing  in  real 
estate,  warehouse  receipts  representing  property  the 
subject  of  sale  in  the  ordinary  business  of  the  corpora- 
tions owning  same,  and  which  warehouse  receipts  are 
pledged  as  collateral  for  such  corporations'  own  debt, 
are  examples  where  the  interest  will  be  deductible  with- 
out limit.*^  If  a  corporation  whose  ordinary  business 
is  the  purchase  and  sale  of  real  estate  has  an  office 
building  under  mortgage,  which  office  building  is  not 
subject  to  sale  in  the  ordinary  business  of  the  corpora- 
tion, the  interest  paid  on  such  mortgage  may  not  be 
deducted  without  limit.^" 

As  A  Dealer  Only.  The  only  corporations  which  will 
be  allowed  under  this  proviso  to  deduct  interest  in  full 

48  T.  D.  1993. 

49  T.  D.  2090. 
60  T.  D.  2137. 


C0RP0R<\TI0N8  146 

are  those  which  are  organized  and  operated  for  the 
purpose  of  buying,  selling  and  dealing  in  the  particular 
kind  of  property  upon  which  the  mortgage  is  given,  and 
the  particular  property  pledged  for  the  debt  upon  which 
the  interest  is  paid  must  be  the  subject  of  sale  in  the 
ordinary  business  of  the  corporation." 

Ordinaby  Business  of  the  Corporation.  Where  a 
corporation  deals  in  the  property  serving  as  collateral 
for  the  indebtedness  as  a  matter  of  its  ordinary  business, 
deduction  may  be  made  in  full,  but  where  the  property  is 
held  by  it  for  the  purpose  of,  or  as  an  instrument  in 
carrying  on,  its  ordinary  business  such  as  the  rights  of 
way  and  other  property  of  public  utility  companies,  per- 
manent oflfice  buildings  and  property  of  like  character 
held  or  occupied  for  the  particular  use  or  purpose  or  the 
furtherance  of  the  objects  of  the  corporation,  the  prop- 
erty is  held  not  to  be  the  subject  of  sale  in  its  ordinarv- 
business,  but  to  be  occupied  or  used  as  an  instrument  of 
carrying  on  the  ordinary  business  for  the  transaction  of 
which  the  corporation  is  organized.  The  fact  that  such 
property  may  be  subject  to  sale  under  extraordinary  or 
peculiar  conditions  does  not  qualify  it  as  collateral." 

Interest  on  Tax  Free  Bonds.  Where  a  corporation 
has  issued  bonds  or  other  indebtedness  with  a  guarantee 
that  the  interest  thereon  shall  be  paid  without  deduction 
for  any  tax  which  the  corporation  may  be  called  upon 
to  pay  or  withhold  under  the  laws  of  the  United  States 
or  of  any  state  or  jurisdiction,  it  is  not  permitted  to 
rioduct  as  additional  payment  of  interest  (or  as  taxes) 

61  T.  D.  1993. 

62  T.  D.  1993. 

F.  I.  Tax.— 10 


146  FEDERAL   INCOME   TAX 

any  amount  which  it  may  be  required  to  pay,  pursuant  to 
such  guarantee,  in  addition  to  the  regular  interest.*^ 

Tajces.  A  corporation  may  deduct  all  taxes  paid  with- 
in the  year  imposed  by  the  authority  of  the  United  States 
(except  income  and  excess  profits  taxes)  or  its  terri- 
tories, or-  possessions,  or  any  foreign  country,  or  under 
the  authority  of  any  state,  county,  school  district,  or 
municipality,  or  other  taxing  subdivision  of  any  state, 
not  including  those  assessed  against  local  benefits.  This 
provision  is  identical  with  the  provisioij  allowing  deduc- 
tion of  taxes  to  individuals.  A  general  discussion  of  the 
limitations  will  be  found  in  the  subsequent  chapter  on 
deductions.^* 

Deduction  of  Dividends  on  Stock  of  Other  Corpora- 
tions. Under  the  1913  Law  corporations  were  not  per- 
mitted to  deduct  from  their  net  income  the  amount 
received  as  -dividends  from  other  corporations  subject 
tQ  the  income  tax.  This  is  likewise  true  under  the  1916 
Law.  For  the  purpose  of  the  1917  Law,  dividends  on 
the  stock  of  such  other  corporations  as  are  taxable  there- 
under on  their  net  income  may  be  deducted.^^  Thus,  for 
the  present  year  a  corporation  may  not  deduct  dividends 
in  computing  the  2%  tax  impos'ed  by  the  1916  Law,  but 
may  do  so  in  computing  the  4%  tax  imposed  by  the 
1917  Law.  Dividends  received  from  foreign  corpora- 
tions which  pay  no  income  tax  to  this  Government  may 
in  no  case  be  deducted. 

Holding  and  Subsidiary  Corporations.  The  fact  that 
one  corporation   may  hold  the  entire  capital   stock  of 

63jVct  of  September  8,  1916,  §  12. 

54  See  Chapter  30. 

68  Act  of  October  3,  1917,  §  4. 


COKI'OKATiONS  147 

another  and  that  the  two  may  be  component  parts  of 
one  business  unit  or  system  does  not  destroy  the  separate 
entities  of  the  two  corporations.  Corporations  as  such 
are  subject  to  the  tax,  not  the  business  organizations  of 
which  the  corporations  may  be  a  part.  Every  corpora- 
tion is  considered  to  be  a  distinct  entity  regardless  of 
its  relation  to  any  other  corporation.  Where  a  parent 
corporation  owns  all  or  practically  all  of  the  stock  of 
subsidiary  companies,  each  must  make  a  true  and  correct 
return  accounting  in  detail  for  their  separate  gross  in- 
comes and  deductions,  and  each  is  required  to  pay  the 
tax  on  the  net  earnings  shown  by  such  return.  The 
parent  company  is  not  permitted  to  report  the  gross 
income  of  all  the  subsidiaries  and  deduct  therefrom  the 
gross  expenses.  The  net  earnings  of  the  subsidiary  com- 
panies turned  over  to  the  parent  company  are  to  be 
treated  as  dividends,  notwithstanding  that  the  earnings 
out  of  which  the  dividends  were  paid  are  also  subject 
to  tax  as  against  the  subsidiary  companies.*®  In  a  case 
under  the  1909  Law  it  was  held  that  although  the  affairs 
of  the  holding  and  operating  company  were  closely  con- 
nected and  they  had  officers  in  common,  the  distinct 
corporate  existence  of  each  should  not  be  ignored  and 
the  holding  company  should  not  be  treated  as  being 
engaged  in  the  l)usiness  of  the  operating  company.*' 

Inactive  Subsidiaries.  The  fact  that  a  corporation 
ha.s  a  number  of  subsidiaries  only  for  the  purpose  of 
protecting  trade  brands,  trade  marks  and  trade  names 
is  imma^rial.  The  liability  to  make  separate  returns 
attaches  to  each  subsidiary  company  by  reason  of  the 
fact  that  it  is  a  separate  and  distinct  entity.     If  such 

66  T.  D.  2137;  T.  D.  2090. 

67  U.  S.  V.  Nipissing  Mines  Co.,  206  Fed.  4.31. 


148  FEDERAL    INCOME   TAX 

subsidiary  has  no  net  income  or  earnings  and  no  ex- 
penses of  operations,  and  if  the  earnings  accrue  direct  to 
the  parent  company,  which  also  pays  direct  the  operating 
expenses  of  the  subsidiaries,  those  facts  should  be  set 
out  in  the  return  of  the  subsidiary,  but  they  do  not 
operate  to  release  the  subsidiary  from  liability  to  make 
a  return.^*  Thus,  subsidiaries  must  in  all  cases  make 
returns  although  they  may  have  no  income  and  be  subject 
to  no  tax. 

Legal  Title  to  Earnings  of  Subsidiaries.  Where  a 
subsidiary  company  kept  no  bank  account,  but  its  earn- 
ings were  deposited  in  the  bank  account  of  the  parent 
company  which  advanced  the  necessary  funds  whenever 
needed  by  the  subsidiary  for  any  operating  expenses,  or 
for  additions  or  betterments,  it  was  held  that  the  actual 
possession  of  the  moneys  did  not  give  the  parent  com- 
pany a  legal  title.  The  annual  earnings  of  the  sub- 
sidiary were  declared  as  dividends  and  at  that  time  the 
dividends  were  income  to  the  holding  eompany.^^ 

Taxability  of  Holding  Companies  on  Bookkeeping 
Credits.  The  Treasur^^  Department  has  held  that  in  a 
case  wherein  a  holding  company  actually  takes  up  each 
month  on  its  b<X)ks  its  proportionate  share  of  the  earn- 
ings of  the  underlying  companies,  such  holding  company 
will  be  required  to  include  in  its  gross  income  the 
amounts  thus  taken  up  regardless  of  the  fact  that  the 
.same  may  not  have  been  actually  paid  to  it  in  cash. 
The  fact  that  the  underlying  companies  credit  to  the 
holding  company  the  amount  of  the  earnings  to  which 

68  T.  D.  2161. 

69  Southern  Pacific  Company  v.  Lowe,  238  Fed.  847. 


CORPORATIONS  14!) 

it  is  entitled  on  the  basis  of  the  stock  it  holds,  together 
with  the  fact  that  the  holding  company  takes  up  on  its 
I  looks  the  amount  thus  credited,  renders  it  incumbent 
upon  the  holding  company  to  return  these  amounts  as 
income,  regardless  of  the  fact  that  the  underlying  com- 
panies needed  the  earnings  and  actually  used  them  in 
making  extensions  and  improvements  and  in  furtherance 
of  their  business.*® 

Gifts  to  Subsidiaries,  In  cases  where  holding  com- 
panies have  made  "gifts"  to  their  subsidiaries  to  make 
up  a  deficit  at  the  end  of  the  accounting  period  of  the 
subsidiary  it  has  been  held  by  the  Treasury  Department 
that  such  "gifts"  were  not  a  proper  deduction  from  the 
net  income  of  the  holding  company  and  were  not  exempt 
when  received  by  the  subsidiary.  This  ruling  was  sup- 
ported by  the  provision  of  the  1913  Law  relating  to  the 
exemption  of  gifts,  but  seems  to  have  no  application  to 
the  1916  Law  in  which  the  provision  as  to  exemption  is 
much  broader.  The  1913  Law  allowed  gifts  to  be  de- 
ducted from  the  net  income  of  individuals  while  the 
present  law  includes  gifts  among  the  other  classes  of 
income  which  are  exempt  from  the  law,  such  as  interest 
on  state,  national  and  municipal  Iwnds,  etc.®* 

Lessor  and  Lessee  Corporations.  The  fact  that  a  cor- 
j)()ration  may  have  leased  all  of  its  property  to  another 
under  a  contract  whereby  the  lessee  corporation  pays  the 
rent  direct  to  the  stockholders  and  bondholders  of  the 

60  T.  D.  21H7.  This  ruling  does  not  seem  to  be  in  accordance 
with  the  rule  fretjuently  announced  by  the  courts  that  mere  book- 
keeping entries  do  not  constitute  income. 

61  Compare  Act  of  October  .3,  1913,  K  B,  and  Act  of  September 
«.  1916,  5  4. 


150  FEDERAL   INCOME   TAX 

lessor  does  not  operate  to  relieve  the  lessor  eorporatiou 
of  liability  to  the  tax  on  the  rental  which  the  lessee  pays 
to  such  stockholders.  Where  under  the  terms  of  a  lease 
a  lessee  agreed  to  pay  the  interest  upon  and  discharge 
the  bonds  issued  by  the  lessor,  to  maintain  the  right  of 
way  and  buildings,  and  to  pay  direct  to  each  stockholder 
of  the  lessor  dividends  at  the  rate  of  eight  per  cent,  per 
annum,  it  was  held  that  the  amounts  paid  to  the  creditors 
and  stockholders  of  the  lessor  were  rents  or  compensa- 
tion to  the  lessor  for  the  use  and  occupation  of  its  prop- 
erty and  constituted  net  income  to  it.  It  was  held  to  be 
immaterial  that  the  dividends  paid  to  the  stockholders  of 
the  lessor  were  fixed  as  to  amount  by  the  lease  and 
paid  direct  to  such  stockholders.  It  was  also  held  to 
be  immaterial  that  the  lessor  was  not  possessed  of  money 
or  other  cash  revenues  with  which  to  pay  the  tax.  The 
lessor  could  not  exonerate  itself  from  liability  for  the 
tax  subsequently  imposed  under  a  law  thereafter  enacted 
by  making  a  lease  of  its  property  which  provided  for 
the  payment  of  all  its  surplus  revenues  direct  to  its 
stockholders. ^2  The  notion  that  a  corporation  is  an 
artificial  entity  distinct  from  the  members  who  com- 
pose it  is  a  fiction  of  the  law  which  the  courts  recognize 
for  some  purposes  and  disregard  for  others.  Thus  the 
fact  that  a  lessee  corporation  pays  the  rent  not  to  the 
lessor  corporation  but  to  its  stockholders  and  bond- 
holders, cannot  prevent  the  lessor  corporation  from  being 
taxable.®^ 

Lessee  Corporations.    A  railroad  company  operating 
leased  or  purchased  lines  is  required  to  include  all  re- 

62  Rensselaer  &  Saratoga  Railroad  Company  v.  Irwin,  239  Fed. 
7.S9 ;  Reg.  33,  Art.  80 ;  T.  D.  2090. 

63  Anderson  v.  Morris  &  Essex  Railroad  Company,  216  Fed.  83. 


CORPORATIONS  151 

ceipts  derived  therefrom,  and  if  the  bonded  indebtedness 
of  such  lines  has  been  assumed  the  operating  company 
may  deduct  the  interest  paid  thereon  to  the  extent  of 
the  limit  allowed  by  law.  Corporations  operating  leased 
lines  should  not  include  the  capital  stock  of  the  lessor 
corporations  in  their  own  statement  of  capital  stock  out- 
standing at  the  close  of  the  year.  The  indebtedness  of 
the  lessor  corporation  should  not  be  included  in  the 
statement  of  the  indebtedness  of  the  lessee  unless  the 
lessee  has  assumed  the  same.®* 

Les-sor  Corporations.  A  corporation  which  has  leased 
its  properties  in  consideration  of  a  rental  equivalent  to  a 
'certain  rate  of  dividends  on  its  outstanding  capital  stock 
and  the  interest  on  bonded  indebtedness,  and  such  rental 
is  paid  by  the  lessee  direct  to  the  stock  and  bond- 
holders, should,  nevertheless,  make  a  return  showing  the 
rental  so  paid  as  having  been  received  by  the  corpora- 
tion.®' 

Treatment  of  Income  by  Stockholders  of  Lessor. 
Where  the  lessor  corporation  is  required  to  report  as  its 
own  income  the  amount  paid  to  its  stockholders  and 
bondholders  by  the  lessee  the  stockholders  should  treat 
the  amounts  received  from  the  lessee  as  dividends  on 
the  stock  by  which  they  hold  in  the  lessor  company.  In 
paying  direct  to  the  stockholders  the  lessee  is  held  to  be 
acting  as  the  agent  of  the  lessor  and  the  amounts  re- 
ceived by  the  stockholders  are  in  eflPect  and  in  fact  divi- 
dends received  out  of  the  earnings  of  the  lessor  and  con- 
sequently not  subject  to  the  normal  tax.®®     Similarly 

•4  Reg.  33,  Art.  82. 
«6Reg.  33,  Art.  80. 
«eT.  D.  2090. 


152  FEDERAL   INCOME  TAX 

bondholders  of  the  lessor  company  should  treat  the 
amounts  received  from  the  lessee  as  interest  upon  the 
indebtedness  of  the  lessor. 

Receivers  for  Corporations.  The  1916  Law  provides 
that  in  cases  where  receivers,  trustees  in  bankruptcy,  or 
assignees  are  operating  the  property  or  business  of  a 
corporation  such  receivers,  trustees,  or  assignees  shall 
made  returns  of  net  income  as  and  for  such  corporation 
in  the  same  manner  and  form  as  is  required  in  the  case 
of  corporations  generally.  Any  income  tax  due  on  the 
basis  of  such  returns  made  by  receivers,  trustees  or  as- 
signees shall  be  assessed  and  collected  in  the  same  man- 
ner as  if  assessed  directly  against  the  corporation.^' 
Receivers  of  corporations  are  not  fiduciaries  within  the 
meaning  of  the  law  and  are  not  governed  by  the  same 
rules  as  are  made  applicable  to  receivers  for  individuals. 
The  receiver  of  a  corporation  stands  in  the  same  posi- 
tion as  the  officers  of  a  solvent  corporation  and  upon  him 
devolve  all  the  duties  of  such  officers  as  to  the  making 
of  returns  and  payment  of  tax.  The  fact  that  the  busi- 
ness and  property  of  the  corporation  are  temporarily 
in  the  hands  of  a  receiver  does  not  alter  the  fact  that 
the  corporation  is  none  the  less  the  beneficiary  of  the 
income  arising  and  accruing.  If  there  is  net  income  it 
is  taxable,  and  the  custodian  of  such  income  is  liable  for 
the  tax  assessable  thereon.  Under  the  1913  Law,  as  well 
as  under  the  1909  Law,  there  was  no  express  provision 
in  the  statute  taxing  corporations  in  the  hands  of  re- 
ceive!^. Several  cases  under  the  1909  Law  held  that 
that  act  did  not  impose  a  tax  on  such  corporations  or 
any  duties  t)n  the  receivers  thereof.  The  1909  Law  was 
a  tax  on  corporations  doing  business  and  it  was  held  in 

67  Act  of  September  8,  1916,  §13,  11(c). 


CORPORATIONS  '  153 

several  cases  that  a  corporation  iu  the  hands  of  receivers 
was  not  one  doing  business  within  the  mesining  of  those 
words  as  used  in  that  act.  Only  one  decision  seems  to 
have  been  rendered  under  the  1913  Law  and  in  that  case 
it  was  held  that  receivers  were  not  subject  to  the  income 
tax  where  the  court  took  possession  of  the  property  of 
an  insolvent  railroad  company  and  operated  the  rail- 
road. The  funds  in  the  hands  of  the  receivers,  repre- 
sented by  the  net  proceeds  in  conducting  the  operation 
of  the  road,  over  and  above  the  authorized  expenditures 
paid  out  by  them,  were  held  not  to  be  subject  to  the  tax 
as  ' '  net  earnings. ' '  ^  The  question  is  no  longer  open 
under  the  express  provisions  of  the  1916  Law. 

Fiscal  Year.  Corporations  are  required  to  make  re- 
ports and  pay  the  tax  for  the  calendar  year  unless  they 
have  duly  designated  a  fiscal  year  in  which  case  the 

W  Equitable  Trust  Company  v.  Western  Pacific  Railway  Com- 
pany, et  al.,  236  Fed.  813.  This  case  was  decided  on  the  authority 
of  Pennsylvania  Steel  Company  v.  New  York  City  Railway  Com- 
pany, in  which  case  the  question  came  up  two  successive  times  in 
the  District  Court  and  once  on  appeal  in  the  Circuit  Court  of 
A  ppeala. 

On  appeal  by  the  Government,  the  Circuit  Court  of  Appeals 
in  affirming  the  lower  court  held.  First,  that  the  taxation  of 
Itiisiness  done  and  income  received  by  receivers  was  not  contem- 
plated by  the  Act,  receivers  not  being  mentioned;  Second,  then* 
can  be  no  doubt  that  the  tax  provide<l  for  by  the  Act  was  imposed 
as  a  tax  upon  doing  business  in  a  corporate  capacity;  Third,  the 
Act  in  all  its  provisions  clearly  contemplated  the  tax  was  to  be 
paid  by  a  corporation  which  was  actually  engaged  in  business 
as  an  actively  operating  concern;  Fourth,  it  was  manifest  that 
the  functions  of  the  company,  as  a  corporation,  were  superseded 
when  all  its  property  was  placed  in  the  hands  of  receivers  by  a 
court  of  equity  in  order  that  it  might  be  saveil  for  the  benefit 
:ill  its  creditors.     (198  Fed.  774;  117  C.  C.  A.  556.) 


154  FEDERAL   INCOME   TAX 

returns  may  be  made  and  the  tax  may  be  paid  upon  the 
basis  of  such  fiscal  year.  The  privilege  of  making  a  re- 
turn of  income  on  the  basis  of  the  fiscal  year  is  limited 
to  corporations.^' 

Keqtjirements  as  to  Fiscal.  Year.  The  fiscal  year 
must  be  a  period  of  twelve  months.  It  cannot  exceed 
that  length  of  time.  In  case  a  corporation  designates  a 
fiscal  year  ending  on  a  date  more  than  twelve  months 
subsequent  to  the  last  day  of  the  calendar  year  or  fiscal 
year  for  which  it  made  its  last  report,  two  reports  are 
required  within  that  period ;  the  first  report  to  cover  that 
■period  of  time  from  the  last  day  of  its  former  accomiting 
period  up  to  the  day  twelve  months  prior  to  the  ending 
of  the  new  fiscal  year.  The  fiscal  year  must  end  upon  the 
last  day  of  some  calendar  month,  as  expressly  provided 
in  the  law.'''*  No  return  rendered  for  a  period  ending  on 
any  date  other  than  the  last  day  of  some  month  will  be 
accepted  unless  it  is  a  "final  return"  and  made  to  the 
day  the  corporation  ceased  business.''^  In  the  case  where 
a  corporation  designates  the  calendar  year  as  its  fiscal 
year  no  notice  or  formality  is  required ;  where  the  fiscal 
year  ends  upon  the  last  day  of  some  month  other  than 
December,  notice  of  the  adoption  of  such  fiscal  year 
must  be  duly  filed  with  the  local  collector. 

How  Designated.  The  fiscal  year  may  be  designated 
by  giving  notice  of  the  day  which  has  been  chosen  as  the 
closing  of  the  fiscal  year  to  the  collector  of  the  district 
in  which  the  corporation  files  its  return  at  any  time  not 
less  than  thirty  days  prior  to  the  first  day  of  March  of 
the  year  in  which  its  return  would  be  filed  if  made  upon 

69  T.  D.  2090. 

70  Act  of  September  8,   1916,   §  13,  H  a. 

71  Mimeograph  letter  to  Collectors  No.  1148. 


CORPORATIONS  155 

the  basis  of  the  calendar  year.  Thus,  for  instance,  a 
corporation  at  present  reporting  for  the  calendar  year^ 
may  adopt  a  fiscal  year  by  giving  notice  to  the  collector 
at  any  time  not  less  than  thirty  days  prior  to  March  1 
of  the  year  following.  Thereafter,  on  or  before  March 
1,  it  will  file  a  return  of  net  income  for  the  period  be- 
ginning January  1  of  tlie  preceding  year  and  ending  the 
day  preceding  the  first  day  of  the  new  fiscal  year,  unless 
such  period  is  more  than  twelve  months,  in  which  case  a 
return  is  required  for  the  preceding  calendar  year  and 
another  return  for  the  part  of  the  following  year  up  to 
the  beginning  of  the  fiscal  period.  That  portion  of  the 
year  preceding  the  beginning  of  an  established  fiscal  year 
is  held  to  be  a  fractional  portion  of  the  calendar  year  and 
the  return  therefor  is  not  required  to  be  filed  before 
^larch  1st  of  the  year  following,  but  it  may  be  filed  at 
any  time  after  the  closing  of  the  period.''*  A  return  for 
the  fiscal  year  will  not  be  accepted  unless  such  fiscal 
year  has  been  properly  established  according  to  the  law 
and  the  rulings  of  the  Treasury  Department."'*  If  due 
notice  has  not  been  filed  with  the  collector  at  least  thirty 
days  prior  to  March  1,  a  return  for  the  preceding  calen- 
dar year  must  be  filed  although  the  corporation  has  in 
fact  established  its  accounting  period  on  the  basis  of  a 
fiscal  year,  other  than  such  calendar  year, 

Xew  Corporations.  The  rulings  as  to  fiscal  year 
apply  to  corporations  which  begin  business  within  the 
year,  as  well  as  to  those  which  were  in  existence  and 
transacted  business  throughout  the  year.  In  the  case  of 
a  new  corporation  the  first  return  may  be  made  for  a 

72  T.  D.  2029. 

73Mimeo^aph  letter  to  Collectors  No.  1148,  T.  T.  S.  1917. 
iri5.'?2. 


156  FEDERAL   INCOME    TAX 

tiscal  year  if  it  has  duly  filed  a  notice  designating  tiie 
same,  provided  the  period  intervening  between  the  date 
of  the  organization  and  the  close  of  the  fiscal  year  does 
not  exceed  twelve  months.  If  such  period  exceeds  twelve 
months,  the  corporation  wiU  be  required  to  make  a  re- 
turn for  the  portion  of  the  calendar  year  preceding  the 
beginning  of  the  fiscal  year,  which  return  must  be  filed 
on  or  before  March  1st  next  following  the  calendar  year 
of  which  it  is  a  part.  Corporations  partially  organized 
are  required  to  file  a  return  for  the  period  ending  De- 
cember 31,  unless  they  have  established  a  fiscal  year 
for  this  purpose.''* 

Notice.  The  notice  must  be  in  writing,  setting  fortli 
that  the  corporation  has  designated  the  last  day  of  some 
month  in  the  year  (other  than  the  last  day  of  December) 
as  the  day  of  the  closing  of  its  fiscal  year,  and  that  from 
the  date  so  designated  its  books  have  been  or  will  be  kept 
on  the  basis  of  such  designated  fiscal  year.'^  The  notice 
should  be  signed  by  the  president  or  other  principal 
officer  of  the  corporation  or  by  the  treasurer,  that  is,  by 
at  least  one  of  the  officers  required  to  sign  the  return  of 
annual  net  income  and  preferably  by  both  of  them.  It 
may  be  given  in  the  form  of  a  letter  addressed  to  the 
local  collector  and  may  be  filed  at  any  time  after  the 
fiscal  year  has  been  established. 

Changing  from  Fiscal  Year  to  Calendar  Year.  A 
corporation  which  has  adopted  a  fiscal  year  and  there- 
after desires  to  change  from  the  fiscal  year  back  to  the 
calendar  ,year  may  do  so  by  designating  the  calendar  year 
as  its  new  fiscal  year,  and  filing  a  notice  accoi-dingly. 

74  T.  D.  2001;  T.  D.  2137. 
76  T.  D.  2090. 


CUKPORATIUNS  157 

Return  of  Annual  Net  Income.  The  duty  to  make  a 
return  depends  upon  the  corporate  existence  and  not 
lipon  the  receipt  of  income.  Every  corporation  not 
specifically  enumerated  as  exempt  is  required  to  make 
a  return  whether  or  not  it  has  any  income  liable  to  tax  ■"* 
or  whether  or  not  it  is  subordinate  to  or  controlled  by 
another  corporation. 

When  Fh^ed.  Unless  a  corporation  has  duly  desig- 
nated a  fiscal  year,  the  return  must  report  the  net  income 
received  within  the  preceding  calendar  year  and  must 
be  filed  on  or  before  the  1st  day  of  March  of  the  year 
following.  If  it  has  duly  designated  a  fiscal  year,  tlu* 
return  may  be  filed  within  sixty  days  after  the  close  of 
such  fiscal  year.''"'  The  time  for  filing  returns  may  be 
extended  as  stated  in  the  chapter  containing  the  general 
provisions  relating  to  returns. 

Where  Filed.  The  return  should  be  filed  with  the  col- 
lector of  the  district  in  which  is  located  the  principal 
office  of  the  corporation  where  are  kept  its  books  of  ac- 
count and  other  data  from  which  the  return  is  prepared. 
If  a  domestic  corporation  keeps  its  books  of  account  and 
other  data  in  a  foreign  country,  the  return  should  be 
made  to  the  collector  of  internal  revenue  in  the  district 
in  which  the  company  has  its  branch  office  in  this  coun- 

76  Reg.  33,  Art.  80;  T.  D.  2090.  Under  the  1909  Law  it  wa*i 
held  that  corporations  of  all  kinds  specified  in  the  Act  as  sul).ie<*t 
to  tlie  tax  were  bound  to  file  returns  though  their  net  profits  were 
not  sufScient  to  render  them  liable  to  the  tax  (U.  S.  v.  Military 
(.'onstruction  Co.,  204  Fed.  IS.'i,)  and  that  the  duty  to  make 
returns  was  not  limited  to  those  the  net  profits  of  which  were 
suflScient  to  render  them  liable  to  the  payment  of  the  tax.  (U.  S. 
V.  Acorn  Roofing. Co.,  204  Fed.  157.) 

77  Act  of  September  8,  1916.  5  13  (b). 


158  KKUEKAL   INCOME   TAX 

try,  if  it  has  such  branch  office;  otherwise  it  should  be 
ihade  in  the  district  in  which  is  located  the  statutory 
office  of  the  corporation,  that  is  the  office  required  to  be 
maintained  in  the  state  of  incorporation  in  accordance 
with  the  statutes  of  that  state. "^^  It  is  to  be  noted  that 
the  return  is  not  to  be  filed  in  the  district  in  which  is 
located  the  statutory  office  unless  the  corporation  has 
no  principal  business  office  or  branch  office  from  which 
the  return  can  be  filed.  The  purpose  of  designating  the 
principal  business  office  is  for  the  convenience  of  the 
Treasury  Department  in  examining  the  books  of  the  cor- 
poration and  verifying  the  return.  Since  the  statute 
now  expressly  designates  the  principal  business  office 
and  describes  it  as  the  place  where  the  books  of  account 
are  kept,  the  filing  of  a  return  from  another  office  may 
not  be  considered  as  a  proper  filing.  The  1913  Law  was 
less  explicit  and  might  have  been  held  to  justify  the 
filing  of  the  return  from  some  other  office  but  the  1916 
Law  is  open  to  no  such  construction.  Subsidiary  com- 
panies are  required  to  file  their  returns  in  the  district 
in  which  they  have  their  principal  accounting  office, 
regardless  of  where  the  parent  company  may  make  its 
return.  If,  however,  subsidiary  companies  do  not  keep 
separate  books  of  account  they  will  be  required  to  file 
their  returns  in  the  same  district  as  the  parent  company, 
but  will  nevertheless  be  required  to  make  separate  re- 
turns.''® Parent  companies  are  required  to  file  with  their 
returns  a  list  of  all  subsidiaries,  with  the  location  of  the 
principal  place  of  business  of  each. 

By  Whom  Filed.     The  responsibility  for  filing  the 
annual  return  rests,  of  course,  upon  the  principal  officers 

78  T.  D.  2137. 

79  T.  D.  2137. 


•  CORPORATIONS  159 

of  the  corporation,  although  there  is  no  penalty  on  such 
oflfifers  personally,  for  failure  to  file  returns.  The  only 
personal  penalty  on  offieere  is  for  making  a  false  or 
fraudulent  return.  In  the. case  of  corporations  in  the 
hands  of  receivers,  the  return  is  made  by  the  receiver 
and  in  the  case  of  dissolved  corporations  it  is  made  by 
the  directors  or  other  persons  in  charge  of  the  winding 
up  of  the  corporation.  Under  the  Corporation  Act  of 
New  Jersey,  which  provides  that  corporations  however 
dissolved  are  "continued  bodies  corporate  for  the  pur- 
pose of  prosecuting  and  defending  suits  by  or  against 
them  and  of  enabling  them  to  settle  and  close  their 
affairs,"  and  constitutes  the  directors  trustees  to  settle 
the  business,  the  oflficers  of  a  corporation  which  had  been 
dissolved  after  becoming  subject  to  the  tax  on  its  income 
of  the  preceding  year,  who  were  also  its  directors,  were 
held  to  have  authority  and  to  be  under  the  duty  of 
making  the  return  of  such  business  required  by  the  1909 
Law.'o 

How  Prepared.  All  questions  on  the  returns  should 
'"'  answered  either  by  the  insertion  of  figures  or  the  in- 

rtion  of  the  word  "none."  In  answer  to  question  No. 
1  the  corporation  should  state  the  total  par  value  of  its 
stock,  both  common  and  preferred  outstanding  at  the 
close  of  the  year.  Stock  outstanding  at  the  close  of  the 
>  oar  and  upon  the  basis  of  which  dividends  are  or  may 
he  paid,  is  held  to  be  paid  up  capital  stock  within  the 
meaning  of  the  law.  For  this  purpose  it  is  immaterial 
whether  the  stock  be  paid  for  in  cash,  promissory  notes 
or  other  assets.  The  fact  that  notes  are  given  in  payment 
of  stock  issued  and  that  the  notes  have  not  been  paid  in 


»0U.  S.  V.  General  Inspection  &  Loading  Co.,  192  Fed.  22.S. 


i 


160  FEDERAL   INCOME   TAX  * 

» 

full  at  the  time  the  return  is  made  is  immaterial.*^  The 
unissued  or  treasury  stock  should  not  be  included,  but 
only  such  stock  as  has  been  actually  issued  and  is  out- 
standing at  the  close  of  the  year,  for  which  payment  has 
been  received.  Where  the  stock  issued  is  payable  in  in- 
stalments or  assessments,  only  so  much  of  it  as  has  been 
actually  paid  in  instalments  and  assessments  should  be 
reported.  In  case  no  stock  is  issued,  there  should  be 
reported  the  amount  of  capital,  not  including  interest- 
bearing  indebtedness,  actually  employed  in  the  business 
and  property  of  the  company  at  the  close  of  the  year. 

Bonded  and  Other  Indebtedness.  Indebtedness  to  be 
included  under  item  2  of  the  return  is  all  interest-bear- 
ing indebtedness  except  that  wholly  secured  by  collateral 
the  subject  of  sale  in  the  ordinary  business  of  the  cor- 
poration. The  amount  outstanding  at  the  close  of  the 
year  should  be  reported  whether  the  interest  accrued 
upon  such  indebtedness  was  actually  paid  within  the 
year  or  not.®^ 

Supplementary  Statement.  The  supplementary 
statement  must  be  filled  out  in  detail  and.  no  return 
which  is  not  substantially  correct  in  this  respect  will  be 
accepted,*^  However,  the  division  indicated  in  the  sup- 
plementary statement  on  the  corporation  forms  has  been 
said  by  the  Treasury  Department  to  be  merely  suggestive. 
It  desires  information  so  far  as  possible  in  detail  as  to 
what  items  go  to  make  up  the  general  expense  and  if  this 
information  is  sufficiently  given  in  detail  in  a  statement 
filed  by  the  corporation  with  the  Public  Service  Com- 

81  T.  D.  2137. 

82  T.  D.  2137. 

83  Mimpograph  letter  to  Collectors  No.  1148. 


CORPORATIONS  161 

mission  of  its  state  the  Treasury  Department  has  no 
ol)jection  to  such  statement  \mng  attached  to  the  return 
in  lieu  of  filling  out  the  supplementary  statement.**  If 
the  books  of  any  corporation  are  kept  in  such  manner  as 
to  make  it  very  difficult  to  give  the  information  in  the 
exact  form  called  for  in  the  supplementary  statement  a 
reasonble  explanation  in  detail  of  the  manner  of  arriving 
at  gross  income  and  expenses  will  be  accepted.  However 
the  information  should  be  furnished  in  such  manner 
that  the  returns  can  be  intelligently  audited  by  the 
Government.** 

Income  prom  State,  National  or  Municipal  Bonds. 
Although  a  corporation  is  not  subject  to  tax  on  interest 
received  from  state,  national  or  municipal  bonds,  as  such 
income  is  exempt,  the  Treasury  Department  requires  the 
corporation  to  report  the  interest  received  from  such 
bonds  in  the  supplementary  statement  on  the  back  of 
the  annual  return.  This  is  required  under  the  provision 
of  the  law  which  calls  for  returns  by  corporations  in 
such  form  as  the  Commissioner  of  Internal  Revenue, 
with  the  approval  of  the  Secretary  of  the  Treasury,  may 
prescribe.  If  a  corporation  fails  to  report  this  species  of 
income  it  will  be  held  by  the  Treasury  Department  to 
not  have  fully  complied  with  the  requirements  of  the 
law  and  to  have  failed  to  make  a  true  and  correct  return 
such  as  the  law,  the  regulations  and  the  prescribed  forms 
require.  There  is  no  specific  provision  of  the  law  where- 
by a  corporation  is  required  to  list  its  holdings  of  such 
bonds,  but  the  regulations  of  the  department  and  the 

M  Letter  from  Treasury  Department  dated  January  6,  1915; 
I.  T.  S.  1917,  1 1589. 

W  Letter  from  Treasury  Department  dated  January  29,  1915; 
I.  T.  8.  1917,  f  1595. 
P.  T.  Tax.— 11 


162  FEDERAL   INCOME   TAX 

form  itself,  which  have  the  force  and  eJffect  of  law,  do 
require  it  and  the  requirements  should  be  complied 
with.** 

How  Signed  and  Swoen  To.  The  return  is  required 
to  be  sworn  to  by  the  president,  vice-president  or  other 
principal  officer  of  the  corporation  and  by  the  treasurer 
or  assistant  treasurer,  and  must  be  verified  under  the 
oath  of  such  officers,  except  in  the  cases  where  the  return 
is  filed  by  a  receiver,  trustee  or  assignee,  or  directors  in 
the  case  of  insolvency,  in  which  cases  the  affidavit  on  the 
return  should  be  changed  in  accordance  with  the  facts. 
As  to  the  general  provisions  respecting  the  oath  or  af- 
firmation see  the  chapter  on  reports.*''' 

Special  Returns  by  Corporations.  In  addition  to  the 
return  of  annual  net  income  required  to  be  filed  by 
every  corporation  several  special  returns  are  required 
annually  or  at  such  times  as  the  Commissioner  of  Internal 
Revenue  may  request. 

Report  op  Dividend  Payments.  Every  corporation, 
when  called  upon  by  the  Commissioner  of  Internal 
Revenue,  is  required  to  render  a  correct  return,  duly 
verified  under  oath,  of  its  payments  of  dividends,  whether 
made  in  cash  or  stock,  including  the  names  and  addresses 
of  stockholders  and  the  number  of  shares  owned  by 
each,  and  the  tax  years  and  the  applicable  amounts  in 
which  such  dividends  were  earned,  in  such  form  and 
manner  as  may  be  prescribed  by  the  Treasury  Depart- 
ment.    This  return  is  for  the  purpose  of  supplying  the 

86  Letter  from  Treasury  Department  dated  March  6,  1916; 
i.   T.   S.   1917,  f  1598. 

87  See  Chapter  3.5. 


UUKPORATIONS  168 

(iovernraent  with  iuformation  against  which  the  aiiuual 

I 

returns  of  stockholders  may  be  compared,  and  is  more 
fully  covered  in  the  chapter  on  Information  at  the 
Source." 

Report  op  Income  Payments.  All  corporations  in 
whatever  capacity  acting,  including  lessees  or  mortgagors 
of  real  or  personal  property,  trustees,  executors,  ad- 
ministrators, receivers,  conservators,  and  employers, 
making  payment  to  any  person,  corporation  or  partner- 
ship of  interest,  rent,  salaries,  wages,  premiums,  annui- 
ties, compensation,  remuneration,  emoluments,  or  other 
fixed  or  determinable  gains  profits  and  income  (other 
than  dividends  and  the  payments  described  in  the  fol- 
lowing section)  of  $800  or  more  in  any  taxable  year,  are 
required  to  make  returns  in  regard  thereto  to  the  Com- 
missioner of  Internal  Revenue  under  regulations  of  the 
Treasury  Department,  setting  forth  the  amount  of  pay- 
ments and  the  names  and  addresses  of  the  recipients. 
In  the  case  of  payments  of  interest  upon  its  bonds, 
mortgages  or  deeds  or  trust  or  similar  obligations,  such 
return  is  required  from  the  corporation  regardless  of 
the  amount  paid.  This  return  is  for  the  purpose  of  sup- 
plying the  Treasury  Department  with  information  to  be 
used  in  auditing  the  returns  of  the  taxpayers  to  whom 
the  income  is  paid,  and  is  more  fully  discussed  in  the 
rliapter  on  Information  at  the  Source.*® 

Reports  By  Brokers.  Every  corporation  doing  busi- 
ness as  a  broker  on  any  exchange  or  board  of  trade  or 
similar  place  of  business  is  required,  when  called  upon 
l»y  the  Commissioner  ef  Internal  Revenue,  to  make  a 

8«See  Chapter  40. 
WT.l. 


164         -  FEDERAL    INCOME    TAX 

retur^i^  showing  the  names  of  customers  with  such  details 
as  to  profits,  losses  or  other  information  which  the  Com- 
missioner may  require,  as  to  each  of  such  customers,  as 
will  enable  the  Commissioner  of  Internal  Eevenue  to 
determine  whether  all  income  tax  due  on  profits  or 
gains  of  such  customers  has  been  paid.  This  report  is 
for  the  purpose  of  information  at  the  source  and  is  more 
fully  covered  in  the  chapter  on  that  subject.^® 

Special  Report  of  Undistributed  Profits  and  Names 
OF  Shareholders.  When  a  corporation  has  permitted 
its  gains  and  profits  to  accumulate  and  become  surplus 
to  such  an  extent  that  the  Secretary  of  the  Treasury 
certifies  that  in  his  opinion  such  accumulation  is  unrea- 
sonable for  the  purpose  of  the  business  it  may  be  required 
by  the  Commissioner  of  Internal  Revenue  or  any  col- 
lector to  file  a  correct  statement  of  such  gains  and 
profits  and  the  names  and  addresses  of  the  individuals  or 
shareholders  who  would  be  entitled  to  the  same  if  divided 
or  distributed.^^  This  return  is  required  under  that 
provision  of  the  1916  Law  which  is  intended  to  prevent 
the  creation  or  use  of  corporations  for  the  purpose  of 
fraudulently  preventing  the  imposition  of  the  supertaxes, 
through  the  medium  of  permitting  the  gains  and  profits 
to  accumulate  instead  of  being  divided  or  distributed. 
The  fact  that  a  corporation  is  a  mere  holding  company 
or  that  the  gains  and  profits  are  permitted  to  accumulate 
beyond  the  reasonable  needs  of  the  business  are  prima 
facie  evidence  of  a  fraudulent  purpose  to  escape  such  tax, 
but  the  Secretary  of  the  Treasury  must  first  certify  that 
in  his  opinion  such  accumulation  is  unreasonable  for  the 
purposes  of  the  business.     When  the  accumulation  has 

90  See  Chapter  40. 

91  Act  of  September  8,  1916,  §  .S. 


CORPORATIONS  165 

been  so  certified  to  be  unreasonable  the  respective  stock- 
holders will  be  required  to  include  in  their  personal 
returns  the  share  of  such  profits  to  which  they  would 
be  entitled  if  they  were  divided  and  distributed. 

Withholding  the  Tax  at  the  Source.  No  withholding 
takes  place  on  payment  of  income  to  domestic  corpora- 
tions. Such  corporations  are  required  to  withhold  the 
tax  on  payments  of  fixed  or  determinable  annual  or 
periodical  income  to  non-resident  aliens,  and  on  pay- 
ments of  bond  interest  and  dividends  to  non-resident 
foreign  corporations  as  indicated  in  the  chapter  on  collec- 
tion at  the  source.^* 

MSee  Chapter  41. 


CHAPTER  13 

SPECIAL  PROVISIONS  APPLYING  TO  INSURANCE  COMPANIES 

In  the  case  of  insurance  companies,  both  domestic  and 
foreign,  certain  special  provisions  govern  the  reporting 
of  income  and  the  making  of  deductions.^  In  general 
domestic  insurance  companies  are  subject  to  the  same  pro- 
visions as  other  domestic  corporations  and  foreign  insur- 
ance companies  are  subject  to  the  same  provisions  as  other 
foreign  corporations.  The  foregoing  chapter  should  be 
consulted  as  to  the  general  provisions  relating  to  cor- 
porations and  the  following  chapter  should  be  consulted 
as  to  the  special  provisions  applicable  to  foreign  cor- 
porations. Two  special  forms  for  making  the  return  of 
annual  net  income  are  provided  for  insurance  companies, 
one  to  be  used  by  mutual  insurance  companies  other  than 
mutual  life  and  mutual  marine,  and  the  other  to  be  used 
by  all  other  insurance  companies  including  mutual  life 
and  mutual  marine. 

Gross  Income.  The  gross  income  of  insurance  com- 
panies consists  of  the  total  revenue  derived  from  the 
operation  of  the  business  including  income,  gains  and 
profits  from  all  other  sources,  except  as  modified  by  the 
express  exemptions  in  the  statute.  The  statements  on  the 
return  of  annual  net  income  should  conform  with  the  re- 
ports of  the  same  years  made  to  the  state  insurance 

1  Act  of  September  8,  1916,  §  12. 

Kir. 


PROVISIONS   APPLYING   TO   INSURANCE   COMPANIES      167 

departments.  Reinsurance  and  return  premiums  should 
not  be  included  in  the  gross  income  or  deductions  of  an 
insurance  company. 

Expenses.  The  same  allowance  for  expenses  is  per- 
mitted as  in  the  case  of  other  corporations.  Insurance 
companies  will  be  permitted  to  add  to  expenses,  in  lieu 
of  depreciation  of  furniture  and  fixtures,  the  actual  cost 
of  repairs,  replacements  and  renewals  on  such  furniture, 
as  is  reported  to  the  state  insurance  department,  pro- 
vided that  in  the  case  of  an  original  investment,  the  cost 
1  hereof  shall  be  charged  to  the  capital  account. 

Deduction  of  Net  Addition  to  Reserve  Funds.  In  the 
ease  of  all  insurance  coiiipauies,  the  net  addition,  if  any, 
required  by  law  to  be  made  within  the  year  to  reserve 
funds  may  be  deducted.  The  net  addition  may  be  based 
upon  the  highest  authorized  reserve  required  by  the 
statutes  of  any  state  in  which  the  company  does  business, 
but  having  adopted  the  requirements  of  one  state  the 
company  cannot  base  its  reserve  upon  the  requirements 
of  another  state  for  subsequent  years."*  Legal  reserve 
funds  are  those  sums  required  by  state  laws  to  be  main- 
tained by  an  insurance  company  to  secure  its  liabilities 
upon  policies  written.  They  are  accumulated  out  of  the 
income  of  the  company  and  are  in  reality  simply  its  in- 
vested assets,  approved  securities  sufficient  in  amount  to 
meet  its  liabilities.  This  reserve  is  not  intended  to 
cover  the  company's  liability  with  respect  to  the  in- 
surance written,  but  is  a  fund  providing  against  loss  in 
case  the  company  should  go  out  of  business.  It  does 
not  secure  all  the  creditors  or  claimants  of  the  company. 
The  computation  of  the  amount  is  ascertained  upon  a 

8T.   n.   1727 


168  FEDERAL   INCOME   TAX 

hypothetical  basis,  and  the  rules  governing  it  are  arbi- 
trary. The  laws  of  the  states,  probably  without  excep- 
tion, require  the  maintenance  of  this  reserve  and  the 
insurance  companies  for  years  have  recognized  the  wis- 
dom of  its  existence. 

Loss  and  unpaid  liability  claims  afford  an  exact  basis 
for  computation,  and  the  reserves  maintained  cover  the 
liability  therefor.  The  state  statutes  most  generally  re- 
quire the  maintenance  of  a  reserve  to  cover  each  class  of 
this  particular  kind  of  insurance,  but  an  insurance  com- 
pany cannot  expand  this  privileged  deduction  to  include 
all  liabilities.  Unpaid  taxes,  unpaid  salaries,  brokerage, 
and  agents'  commissions  are  current  expenses;  they  are 
essential  items  of  expense  in  the  daily,  monthly,  and 
yearly  conduct  of  the  company's  business;  the  amount 
and  date  of  payment  is  fixed  and  determined;  they  de- 
pend for  liquidation  solely  upon  the  company's  earning 
capacity  as  the  business  progresses.  Apparently  no  state 
law  requires  the  maintenance  of  a  reserve  to  secure  these 
payments.  A  permanent  reserve  for  taxes  is  not  neces- 
sary or  required  by  law,  and  they  are  not  properly  in- 
eluded  in  the  net  additions  required  by  law  to  reserve 
funds.  The  income  tax  law  specifically  limits  the  de- 
ductions to  sums  required  by  law,  not  such  reservations 
as  business  prudence  may  suggest,  and  the  express  pro- 
visions of  the  law  fix  the  determining  basis.* 

Reserves  Required  by  Law.  Only  those  reserves  which 
are  "required  by  law"  may  be  deducted.  Under  the 
laws  of  Pennsylvania  reserves  against  unpaid  losses  are 
required  by  law  of  casualty  companies,  but  not  of  fire 
and  marine  insurance  companies.  Hence,  the  latter  can- 
not  deduct   reserves   against  losses,   although   the   In- 

3  Maryland  Casualty  Co.  v.  U.  8.,  Court  of  Claims,  T.  D.  2451. 


PROVISIONS  APPLYING   TO   INSURANCE  COMPANIES     169 

surance  Commissioner  of  Pennsylvania  may  require  such 
reserves  under  a  practice  of  his  office  established  for 
many  years  and  relied  upon  as  an  administrative  inter- 
pretation of  the  law  of  that  state  * 

RELE.VSED  Reserves.  Where  there  has  been  a  decrease 
in  reserve  funds  the  amount  of  the  decrease  is  commonly 
called  released  reserve,  and  is  to  be  treated  as  income 
for  the  year  in  which  the  reserve  is  released.  Released 
reserves  though  not  mentioned  in  express  terms  in  the 
law  have  been  held  to  be  income  and  taxable  for  the  year 
in  which  released.' 

Assessment  Insurance  Companies.  In  the  case  of 
assessment  insurance  companies,  whether  domestic  or 
foreign,  the  actual  deposits  of  sums  with  state  or  terri- 
torial officers,  pursuant  to  law,  as  additions  to  guaranty 
or  reserve  funds  shall  be  treated  as  being  payments  re- 
<inired  by  law  to  reserve  funds.® 

Payments  on  Policies.  All  insurance  companies  may 
deduct  the  sums,  other  than  dividends,  paid  within  the 
year  on  policy  and  annuity  contracts.  Under  this  item 
on  the  return  of  annual  net  income  may  be  included  all 
death,  disability  or  other  policy  claims,  including  fire, 
accident  and  liability  losses,  matured  endowments,  pay- 
ments on  instalment  policies,  surrender  values  and  all 
claims  actually  paid  under  the  terms  of  policy  contracts. 
In  the  case  of  life  insurance  companies  amounts  paid  as 

♦  McCoach  V.  Insurance  Company  of  North  America,  228  IT.  S. 
295. 

6  Maryland  Casualty  Company  v.  U.  8.,  Court  of  Claims,  T.  D. 
2451. 

?  Act  of  September  8,  1916,  S  12,  Subdiv.  (c). 


170  FEDERAL,   INCOME   TAX 

consideration  for  supplementary  contracts,  and  applied 
surrender  values,  should  be  separately  reported." 

Mutual  Fire  Insurance  Companies.  Companies  of 
this  character  are  required  to  report  under  a  special  pro- 
vision of  the  1916  Law  which  provides  that  such  com- 
panies requiring  their  members  to  make  premium 
deposits  to  provide  for  losses  and  expenses  shall  not  re- 
turn as  income  any  portion  of.  the  premium  deposits  re- 
turned to  the  policyholders,  but  shall  return  as  taxable 
income  all  income  received  by  them  from  all  other 
sources  plus  such  portions  of  the  premium  deposits  as 
are  retained  by  the  companies  for  purposes  other  than 
the  payment  of  losses  and  expenses  and  reinsurance  re- 
serves. Under  this  provision  the  Treasury  Department 
has  prescribed  a  special  form  for  such  companies.' 

Capital  Employed  in  Business.  The  capital  em- 
ployed in  business  by  such  companies  is  held  to  be  the 
capital  invested  in  real  estate  and  other  assets. 

Indebtedness.  The  interest-bearing  indebtedness  of 
such  companies  is  required  to  be  reported.  The  amount 
should  include  all  such  indebtedness  for  the  payment 
of  which  the  company  or  its  property  is  bound,  but  not 
indebtedness  wholly  secured  by  collateral  the  subject  of 
sale  or  hypothecation  in  the  ordinary  business  of  the 
company. 

Premiums.  The  amount  to  be  reported  as  premiums 
includes  the  net  amount  received  from  the  policyholders 
after  deducting  therefrom  the  premiums  returned  and 

f  Instructions  on  Form  1 0.^0. 
a  Form  lO.'^OA. 


I'RUVISIONS   APPLYING    TO    INSUB.VMCE   COMPANIES      171 

such  portion  of  the  premiums  as  is  retained  for  the  pay- 
ment of  losses,  expenses  and  reinsurance  reserves.  Only 
that  part,  of  the  premiums  retained  for  any  other  pur- 
pose is  taxable  income  and  should  be  returned  as  such. 

Profit  ON  Sale  or  Maturity  op  Ledger  Assets.  The 
profit  or  income  to  be  returned  in  the  event  of  sale  or 
maturity  of  capital  assets  should  be  determined  in  the 
same  manner  as  in  the  case  of  other  corporations.  The 
profit  or  income  may,  for  the  purpose  of  the  tax,  be  re- 
duced by  the  amount  of  any  loss  resulting  from  the  same 
source  and  ascertained  in  the  same  manner.  In  no  event 
can  a  loss  resulting  from  the  sale  or  maturity  of  capital 
as.sets  exceed  the  profit  within  the  year  from  like  trans- 
actions. 

Rentals.  Rentals  to  be  reported  as  income  include 
the  net  amount  of  all  payments  received  in  cash  or  its 
ecjuivalent,  as  rent  on  buildings  or  other  property  owned 
or  controlled  by  the  company  making  the  return,  after 
deducting  rents  paid  by  the  company  and  also  such 
amounts  of  repairs  and  expenses,  including  taxes,  as  have 
been  expended  on  the  property  from  which  the  rental 
income  reported  was  derived. 

Interest  on  Bonds.  The  interest  received  on  bonds 
to  be  reported  as  income  does  not  include  interest  exempt 
from  tax  under  the  1916  Law. 

Commissions  on  Reinsurance.  Commissions  received 
for  reinsurance  to  be  reported  as  income  should  be  the 
net  amount  after  deducting  the  amount  of  reinsurance 
fommissions  actually  paid  within  the  year. 


172  FEDERAL   INCOME   TAX 

Deductions.  No  deductions  are  permitted  to  be  made 
from  the  amount  of  income  reported  by  mutual  fire  in- 
surance companies.  The  amount  of  premiums,  assess- 
ments, fees,  etc.,  reported  as  income  is  such  an  amount  as 
is  retained  for  purposes  other  than  the  payment  of 
losses,  expenses  and  reinsurance  reserves  hence  the  ex- 
penses of  doing  business  of  the  company  are  deducted 
from  the  amount  of  such  premiums  before  the  sum  is 
reported  in  the  return.  Similarly  the  amount  received 
as  rent  on  buildings  owned  by  such  companies  is  the 
net  amount  after  deducting  rentals  paid  by  the  company 
on  buildings  which  it  may  occupy  as  a  tenant,  taxes  paid 
by  the  company  on  buildings  which  it  owns,  and  repairs 
and  expenses  incident  to  the  operation  of  buildings 
which  it  owns.  Thus  it  will  be  seen  that  the  report  for 
mutual  insurance  companies  is  a  report  of  net  income 
in  the  true  sense  of  the  word,  the  gross  income  not  being 
reported  except  so  far  as  is  required  for  purposes  of  in- 
formation in  fhe  supplementary  statement  on  the  back 
of  the  return. 

Mutual  Employers'  Liability  Insurance  Companies. 
The  1916  Law  included  companies  of  this  class  in  the 
same  class  as  mutual  fire  insurance  companies  and  the 
statement  in  the  preceding  paragraphs  regarding  such 
companies  applies  equally  to  this  class  of  companies. 

Mutual  Workmen's  Compensation  Companies.  The 
1916  Law  included  companies  of  this  class  in  the  same 
class  as  mutual  fire  insurance  companies  and  the  state- 
ment in  the  preceding  paragraphs  regarding  such  com- 
panies applies  equally  to  this  class  of  companies. 

Mutual  Casualty  Insurance  Companies.  The  1916 
Law  included  companies  of  this  class  in  the  same  class 


I'KOVISIONS   APPLYING    TO    INSURANCE   COMPANIES      173 

as  mutual  fire  insurance  companies  and  the  statement  in 
the  preceding  paragraphs  regarding  such  companies  ap- 
plies equally  to  this  class  of  companies. 

Mutual  Marine  Insurance  Companies.  Mutual  marine 
insurance  companies  are  reciuired  to  include  in  their 
return  of  gross  income  gross  premiums  collected  and  re- 
ceived by  them  less  amounts  paid  for  reinsurance,  but 
are  entitled  to  include  in  the  deductions  from  gross  in- 
come amounts  repaid  to  policyholders  on  account  of 
premiums  previously  paid  by  them,  together  with  in- 
terest upon  such  amounts  between  the  ascertainment 
thereof  and  the  payment  thereof.®  In  other  respects 
the  companies  of  thi%  class  proceed  in  the  same  manner 
as  insurance  companies  generally. 

Life  Insurance  Companies.  Life  insurance  com- 
panies, including  stock  and  mutual  companies,  do  not  in- 
clude as  income  in,  any  year  such  portion  of  any  actual 
premium  received  from  any  individual  policyholder  as 
shall  have  been  paid  back  or  credited  to  such  individual 
policyholder  or  treated  as  an  abatement  of  premium 
within  the  year.^®  In  so  far  as  "deferred  dividends" 
payable  at  a  stated  period  represent  "a  portion  of  any 
actual  premium  received,"  they  may  be  omitted  from 
gross  income  for  the  year  in  which  they  were  actually 
paid  back,  except  that  so  much  of  any  deferred  dividends 

9  Act  of  September  8,  1916,  §  12 ;  Keg,  33,  Art.  99. 

10  Under  the  1909  Law  there  was  much  litigation  as  to  whether 
so  called  dividends  paid  by  insurance  companies  to  policyholders 
as  a  return  of  a  part  of  the  premium  were  properly  deductible. 
The  courts  held  that  the  so-called  dividends  awarded  annually  to 
policyholders  did  not  constitute  income  (Herold  v.  Mutual  Benefit 
Life  Insurance  Company,  201  Fed.  918)  and  at  the  time  of  the 
enactment  of  the  1913  Law  the  point  was  expressly  covered  by 
the  same  language  as  in  the  present  law. 


174  FEDERAL   INCOME   TAX 

paid  during  the  tax  year  to  the  individual  policyholder 
as  exceeds  the  amount  of  premiums  paid  during  the  same 
year  may  not  be  omitted.  Only  the  actual  amount  of 
dividends  actually  credited  or  apportioned  to  a  policy- 
holder during  the  premium-paying  period,  and  not  any 
accretions  thereto,  can  be  excluded  from  gross  income. 
In  the  cases  of  whole  life  or  five-year  distribution  policies, 
deferred  dividends  may  be  excluded  from  gross  income 
to  the  extent  that  they  are  paid  back  or  credited  to  the 
insured  or  used  as  an  abatement  of  annual  premiums.^^ 

Supplementary  Policy  Contracts.  Where  a  life  in- 
surance company's  policies  contain  an  option  to  have 
proceeds  paid  in  annual  instalments  for  a  given  term  of 
years,  or  during  the  lifetime  of  the  beneficiary,  instead 
of  in  one  sum,  such  policies,  if  the  option  is  exercised, 
are  styled  "supplementary  policy  contracts."  These 
obligations  are  protected  by  reserves,  the  net  additions 
to  which  are  deductible  if  such  reserves  are  "required 
by  law."  The  Commissioners  of  Insurance  of  all  the 
states  require  the  establishment  of  a  reserve  to  cover 
the  obligations  of  the  company  on  such  supplementary 
policy  contracts.  This  fact  of  itself  tends  strongly  to 
show  that  they  are  required  by  law,^**  but  if  the  action 
of  a  commissioner  of  insurance  is  based  in  such  cases 
upon  the  practice  of  his  office  and  not  upon  an  express 
requirement  of  law,  deduction  may  not  be  made.^' 

Payments  on  Policies.  Surrender  values  applied  in 
any  manner,  consideration  for  supplementary  policy  con- 

11  Reg.  33,  Art.  100. 

12  Mutual  Benefit  Life  Ins.  Co.  v.  Herold,  198  Fed.  199. 

13  See  Maryland  Casualty  Co.  v.  IT.  S.,  Court  of  Claims,  T.  D. 
2451. 


HK0V1S1ON8   APPLYING   TO   INSURANCE   COMPANIES      175 

tracts,  involving  and  not  involving  life  contingencies, 
should  be  included  in  the  income  of  life  insurance  com- 
panies. Applied  surrender  values  and  consideration  for 
supplementary  contracts  not  involving  life  contingencies 
included  in  income  are  deductible  as  payments  under 
policy  contracts,  but  for  convenience  in  verifying  the 
returns  these  items  should  appear  in  the  return  in  both 
gross  income  and  deductions.** 

Mutual  Life  Insurance  Companies.  Mutual  life  in- 
surance companies  file  the  same  return  as  stock  com- 
panies and  are  governed  by  same  rules  with  respect  to 
computing  net  income. 

14  Reg.  33,  Arts.  101  and  102. 


CHAPTER  14 

FOREIGN  CORPORATIONS 

The  1916  Law  provides  that  the  income  tax  shall  be 
assessed  and  collected  annually  upon  the  total  net  income 
received  by  every  corporation,  organized,  authorized  or 
existing  under  the  laws  of  a  foreign  country,  including 
interest  on  bonds,  notes,  or  other  iuterest-'bearing  obliga- 
tions of  residents,  corporate  or  otherwise,  and  including 
the  income  derived  from  dividends  of  corporations  whose 
net  income  is  taxable  under  the  law.^  The  deductions 
permitted  to  foreign  corporations  are  in  general  the  same 
as  those  permitted  to  domestic  corporations  but  speci- 
fically limited  to  the  business  or  property  in  this  country. 
This  chapter  deals  with  the  special  provisions  applicable 
to  foreign  corporations.  The  chapter  on  domestic  cor- 
porations should  be  referred  to  for  provisions  which 
have  general  application  to  all  corporations. 

1  Act  of  September  8,  1916,  §  10.  Under  the  1913  Law  foreign 
corporations  were  taxable  only  upon  the  income  accruing  from 
business  transacted  and  capital  invested  within  the  United  States. 
Interest  and  dividends  received  by  foreign  corporations  were  held 
to  be  income  from  capital  invested  in  this  country,  although  at 
first  it  was  held  under  that  law  that  interest  and  dividends 
received  by  non-resident  alien  individuals  were  not  subject  to  tax, 
but  after  the  decision  in  the  case  of  Brushal)er  v.  Union  Pacific 
Railway  Company,  240  U.  S,  1,  the  Treasury  Department  changcfl 
its  rulings  and  held  that  interest  and  dividends  so  received  were 
subject  to  the  tax,  whether  the  recipif'nt  wns  an  individual  or  a 
corporation.     (T.  D.  2313.) 

176 


FOKBIGN    CORPORATIONS  177 

Corporations  Exempt  from  the  Tax.  The  corpora- 
tions enumerated  in  the  law  as  exempt  include  foreign 
corporations  as  well  as  domestic  corporations,  except  as 
stated  in  the  chapter  on  exempt  corporations.* 

Corporations  Subject  to  the  Tax.  All  foreign  corpo- 
rations deriving  income  from  sources  within  this  country 
and  not  specifically  exempt  as  indicated  above  are  sub- 
ject to  the  tax. 

Sale  of  Goods  by  Correspondence.  Where  a  foreign 
corporation  sells  goods  in  this  country  by  correspondence, 
or  delivers  goods  so  sold  to  a  citizen  or  resident  of  this 
country,  no  attempt  is  made  to  impose  the  tax  on  such 
transactions.  The  conclusion  seems  to  be  that  such  sales 
do  not  create  any  income  from  sources  within  the  United 
States.  This  seems  to  be  true  in  all  cases  where  the 
contract  for  the  sale  of  goods  is  made  in  a  foreign 
jurisdiction  whether  the  title  to  the  goods  passes  in  the 
foreign  jurisdiction  or  title  is  retained  after  the  goods 
arrive  in  this  country  until  payinent  therefor  has  been 
made.  Where,  however,  a  resident  of  this  country  pays 
interest  on  any  deferred  payments  of  purchase  price  the 
interest  is  clearly  subject  to  tax  under  the  express  pro- 
visions of  the  law. 

Traveling  Salesmen.  The  Treasury  Department  has 
held  as  follows:  Where  a  foreign  corporation  sends  a 
representative  to  this  country  to  solicit  business,  the 
merchandise  thus  sold  to  be  shipped  direct  to  the  con- 
signee, the  corporation  is  transacting  business  in  this 
country.  The  fact  that  the  solicitor  or  representative  has 
only  a  mailing  address  in  this  country  is  immaterial,  as 

8  See  Chapter  15. 
F.  I.  Tax.— 12 


178  FEDERAL   INCOME    TAX 

he  is  none  the  less  an  agent  of  the  foreign  corporation. 
To  the  extent  that  he  sells  in  this  country  goods  or  mer- 
chandise for  the  foreign  corporation,  to  that  extent  the 
foreign  corporation  is  transacting  business  in  the  United 
States  and  is  required  to  make  a  return  to  the  collector 
in  the  district  in  which  its  representative  has  his  mailing 
address.®  An  agent  who  is  doing  business  in  this  coun- 
try^ buying  and  selling  certain  products  of  the  foreign 
corporation,  is  to  all  intents  and  purposes  a  branch  of 
the  foreign  corporation  as  through  and  by  him  the 
foreign  corporation  is  transacting  business  here.  The 
buying  and  selling  of  products  in  this  country  through  a 
local  agency  or  branch  is  clearly  transacting  business 
here.*  Under  the  1913  Law  it  was  held  that  a  foreign 
corporation  was  subject  to  the  tax  on  income  accruing 
from  business  transacted  and  capital  invested  within 
the  United  States,  where  (a)  it  sent  agents  into  the 
United  States  to  solicit  purchasers  for  its  products, 
hiring  desk  room  in  the  United  States  and  empowering 
the  salesmen  to  make  written  contracts,  (b)  shipped  its 
product  consigned  to  itself  in  the  United  States  to  dif- 
ferent points  where  it  hired  storage  rooms  and  stored 
the  product  in  its  own  name  and  at  its  own  risk  to  insure 
delivery  according  to  contract,  and  to  meet  anticipated 
demands.^ 

3  T.  D.  2161. 

4T.  D.  2137. 

SLaurentide  Co.  Ltd.  v.  Durey,  231  Fed.  223.  The  court  said 
in  part:  "I  think  it  would  be  somewhat  difficult  for  the  Lauren- 
tide  Co.,  Ltd.,  or  its  able  attorney,  to  describe  what  it  was  doin^ 
in  the  United  States,  if  it  was  not  doing,  carrying  on  and  trans- 
acting business  therein,  when  there  receiving  large  quantities  of" 
newspaper,  consigned  to  itself  and  storing  it,  hiring  and  paying 
for  storage  room  therefor,  delivering  it  to  customers,  purchasers 
thereof,  soliciting  contract  by  agents  for  the  purchase  and  supply 


KOBKKJN    CORI'ORATIONS  17!) 

Foreign  Steamship  Companies.  Foreign  steamship 
companies  engaged  in  the  business  of  transporting  pas- 
sengers, goods  and  merchandise  between  ports  in  this 
country  and  foreign  ports  and  maintaining  passenger 
and  freight  agencies  in  this  country,  are  doing  business 
here  and  subject  to  the  income  tax.  There  seems  to  be 
no  question  of  constitutionality  involved  in  such  tax  being 
a  tax  on  exports.®  A'  firm  in  Great  Britain  chartered  its 
vessels  (tramp  steamers)  to  residents  of  the  United 
States  who  operated  them  from  ports  in  this  country. 
It  was  held  by  the  Treasury  Department  that- the  net 
income  accruing  to  the  foreign  firm  as  a  result  of  this 
transaction  was  income  derived  from  capital  invested  and 
business  transacted  in  the  United  States,  on  the  ground 
that  steamers  chartered  to  parties  in  the  United  States 
occupied  the  same  position  for  the  purpose  of  the  income 
tax  law  as  do  branches  of  foreign  corporations  located 
in   the  United  States.''     Foreign  steamship   companies 

of  same,  renting  and  paying  rent  for  a  room  for  doing  the  busi- 
ness, depositing  and  collecting  the  checks  received  in  payment  and 
paying  the  expense  of  the  business  therefrom,  all  done  in  the 
State  of  New  York  in  the  United  States.  It  was  not  necessary 
that  the  contracts  shoulcj  have  been  made  wholly  in  the  United 
States,  or  that  their  execution  or  performance  should  have  been 
wholly  in  the  United  States."  Under  the  1909  Law  it  was  held 
that  where  the  foreign  corporation  owned  timberlands  in  this 
country  and  operated  a  match  factory  but  sold  its  lands  and  plant, 
payments  to  be  made  in  instalments,  the  foreign  company  to 
retain  the  title  until  paid  in  full,  it  was  not  doing  business, 
although  retaining  an  attorney  in  the  state  to  look  after  its 
interest  and  an  agent  for  service  of  process  as  required  by  state 
statute.  (Bryant  and  May,  Limited,  v.  Scott,  226  Fed.  875.) 
Under  the  same  state  of  facts  the  corporation  would  be  taxable 
under  the  present  law. 

8  28  Op.  Atty.  Gen.  211 ;  Aguirre  v.  Maxwell,  8  Blatch.  140. 

7  Letter  from  Treasury  Department  dated  December  8.  1916. 


180  FEDERAL   INCOME   TAX 

having  no  office  in  the  United  States,  whose  vessels  only 
occasionally  touch  at  ports  in  the  United  States,  were 
not  regarded,  as  doing  business  in  this  country  within 
the  meaning  of  the  1909  Law,'  but  the  point  has  not 
l>een  ruled  upon  under  the  1916  Law. 

Foreign  Governments.  Under  the  1916  Law,  prior  to 
the  amendment  of  October  3,  191'Z,  it  was  held  by  the 
Treasury  Department  that  the  income  accruing  to  a' 
foreign  government  from  sources  within  the  United 
States  arising  from  interest  on  bonds  or  dividends  on 
stock  of  domestic  corporations  was  subject  to  tax.  The 
law  now  provides  that  nothing  in  the  1913  Law  or  the 
1916  Law  shall  be  construed  as  taxing  the  income  of 
foreign  governments  received  from  investments  in  the 
United  States  in  stocks,  bonds,  or  other  domestic  securi- 
ties, owned  by  such  foreign  governments,  or  from  the 
interest  on  deposits  in  banks  in  the  United  States  of 
moneys  belonging  to  foreign  governments.® 

Resident  Alien  Corporations.  A  resident  alien  cor- 
poration is  a  foreign  corporation  having  an  office  or  place 
of  business  in  the  United  States.^**  Such  corporations, 
being  within  the  jurisdiction  of  the  United  States,  are 
required  to  file  returns  in  the  same  manner  as  domestic 
corporations,  disclosing  their  net  income  from  sources 
within  the  United  States,  but  are  allowed  only  the  de- 
ductions and  exemptions  permitted  to  foreign  corpora- 
tions. No  withholding  of  the  tax  at  the  source  takes 
place  against  such  corporations.^^  Being  taxable  under 
the  law  the  dividends  of  such  corporations  are  corres- 

8T.  D.  1675. 

9  T.  D.  2425 ;  Aet  of  September  8,  1916,  as  amended  by  Act  of 
October  3,  1917,  §30. 

10  T.  D.  2401. 

11  Reg.  33,  Art.  46. 


i 


FOREIGN    CORPORATIONS  181 

poudingly  exempt  to  the  same  extent  as  dividends  of 
domestic  corporations.  Interest  on  the  obligations  of 
such  corporations  would  seem  to  be  taxable  in  the  hands 
of  non-resident  aliens  and  subject  to  deduction  of  the 
tax  when  paid  to  non-resident  foreign  partnerships  or 
corporations.**  The  term  ''resident  foreign  corpora- 
tions" is  used  in  this  book  to  indicate  corporations  of 
this  class. 

Non-Resident  Alien  Corporations.  The  term  "non- 
resident alien  corporations"  covers  all  corporations  or- 
ganized, authorized  or  existing  under  the  laws  of  a 
foreign  country  and  having  no  office  or  place  of  business 
in  the  United  States."  Such  corporations  are  subject  to 
the  tax  on  all  income  from  sources  within  the  United 
States,  and  are  required  to  file  annual  returns  disclosing 
such  income.  Since  such  corporations  are  outside  of  the 
jurisdiction  of  this  country,  the  act  provides  expressly 
that  the  tax  on  income  from  interest  on  bonds  and  divi- 
dends on  stock  of  resident  corporations  shall  be  withheld 
at  the  source  before  the  income  leaves  this  jurisdiction. 
Provision  is  also  made  for  collection  of  the  tax  by 
impressing  a  duty  upon  those  in  this  country  who  have 
control,  custody,  receipt  or  disposal  of  the  income  of  such 
corporations,  as  indicated  in  the  following  paragraphs. 
The  term  "non-resident  foreign  corporations"  is  used  \n 
this  book  to  indicate  corporations  of  this  class. 

Collection  of  the  Tax  at  the  Source.  In  the  case  of 
non-resident   alien    corporations   a.s   defined   above,   the 

1«  Act  of  September  8,  1916,  §  1  and  8  l.'J  (e)  as  amended. 
Residence  within  the  meaninjj  of  these  provisions  will  probably 
be  held  to  cover  only  cases  where  the  principal  business  of  the 
foreign  corporation  is  transacted  in  this  country,  and  payment  of 
the  interest  is  made  here. 

18  T.  D.  2401. 


182  FEDERAL   INCOME   TAX 

normal  tax  is  withheld  at  the  source  on  all  interest  upon 
the  bonds  and  mortgages  or  deeds  of  trust  or  similar  obli- 
gations of  resident  corporations  and  upon  all  dividends 
upon  the  capital  stock  or  from  the  net  earnings  of  res- 
ident corporations.  Such  corporations  cannot  by  filing 
any  certificate  or  claim  for  exemption  prevent  the  with- 
holding of  such  tax,  but  may  upon  the  filing  of  an  annual 
return,  which  must  include  the  amount  of  income  on 
which  the  tax  has  been  so  withheld,  claim  a  deduction  of 
the  amount  so  withheld  and  if  the  return  discloses  the 
fact  that  more  tax  has  been  withheld  than  is  assessable 
against  the  corporation,  the  Treasury  Department  will 
order  a  refund  of  the  excess  amount  withheld.  For  this 
purpose  the  return  of  the  foreign  corporation  should 
have  attached  thereto  a  statement  giving  the  names  of 
the  withholding  agents  and  the  amounts  withheld  re- 
spectively. For  a  further  discussion  of  collection  at  the 
source  see  the  chapter  on  that  subject.  There  is  no 
collection  of  the  tax  at  the  source  on  payments  other 
than  those  described  above,  and  in  no  case  on  payments 
made  to  resident  alien  corporations. 

Nominal  Stockholders.  Where  stock  of  domestic  cor- 
porations stands  in  the  name  of  nominal  stockholders 
and  the  actual  owners  are  non-resident  foreign  corpora- 
tions, that  fact  must  be  disclosed.  In  cases  where  such 
corporations  are  nominal  stockholders,  withholding  of 
the  tax  may  be  avoided  by  disclosing  the  actual  owners. 
This  subject  is  discussed  in  a  preceding  chapter.^* 

Resident  Agents  for  Foreign  Corporations.  In  addi- 
tion to  the  provisions  prescribed  by  the  law  for  collection 
of  the  tax  at  the  source  on  bond  interest  and  dividends 

14  See  Chapter  7. 


FOREIGN    CORPORATIONS  183 

paid  to  non-resident  foreign  corporations,  the  Treasury 
Department  has  evolved  a  method  of  collecting  the  tax 
by  impressing  upon  residents  of  this  country,  under  cer- 
tain circumstances,  the  duty  of  filing  returns  and  ac- 
counting for  the  tax  due  from  foreign  corporations  on 
the  income  which  passes  through  their  hands.  A  general 
discussion  of  the  duties  of  such  agents  and  their  relation 
to  the  foreign-corporation  principal  is  contained  in  a 
preceding  chapter  on  Resident  Agents  for  Non-resident 
Aliens  and  Foreign  Corporations.^' 

Income  Subject  to  Tax.  The  gross  income  of  foreign 
corporations  is  all  taxable  income  received  from  all 
sources  within  the  United  States,  whether  or  not  the  cor- 
poration does  business  in  this  country  or  receives  income 
from  investments  of  any  kind.  From  the  amount  of  such 
gross  income  may  be  subtracted  the  sum  of  the  deduc- 
tions enumerated  in  the  act,  which  deductions  are  similar 
to  those  allowed  to  domestic  corporations,  but  limited 
to  expenses  or  allowances  properly  chargeable  against 
(the  income  from  this  country. 

Steamship  Companies.  Where  a  foreign  steamship 
company  has  steamers  which  touch  American  ports  and 
which  carry  therefrom  freight  and  passengers  the  return 
should  show  as  gross  income  the  total  receipts  from  all 
outgoing  boats  whether  freight  or  passenger.  With  the 
gross  income  thus  ascertained,  the  ratio  existing  between 
it  and  the  gross  income  from  all  ports  both  within  and 
without  the  United  States  should  be  determined  as  the 
basis  upon  which  deductions  may  be  computed.** 

15  See  Chapter  6. 

18  Letter  _  from  Treasury  Department  daterl  July  18,  1916: 
I    T.  8.  1917,  miU. 


184  '         federal  income  tax 

Foreign  Corporations  Having  Branch  Offices  in 
This  Country.  Where  a  foreign  corporation  has  one  or 
more  branch  offices  in  this  country  the  return  should 
include  the  income  of  all  the  branches,  including 
branches  in  the  Philippines  and  Porto  Rico.  The  princi- 
pal branch  office  determines  the  district  in  which  the 
return  should  be  filed  and  the  tax  should  be  paid.  Where 
branches  in  this  country  transact  business  in  foreign 
jurisdictions,  the  net  income  accruing  to  the  branch 
here,  it  seems  that  the  income  derived  from  such  business 
in  foreign  jurisdictions  should  be  treated  as  income  from 
sources  within  this  country  since  the  management  an^ 
conduct  of  such  business  is  directed  from  within  this 
jurisdiction  and  the  foreign  corporation  eventuallj'^  re- 
ceives its  net  income  from  a  source  within  this  country, 
namely  the  branch  conducting  such  business. 

Income  from  Investments.  Income  from  invest- 
ments of  all  kinds  in  property  located  within  this  coun- 
try is  subject  to  the  tax  under  the  broad  provisions  of 
the  law  which  provide  for  the  taxation  of  the  total  net 
income  from  all  sources  within  the  United  States.^' 

17  Under  the  1913  Law,  the  tax  was  imposed  only  upon  such 
foreign  corporations  as  were  doing  business  and  had  capital 
invested  in  this  country.  The  Treasury  Department  construed 
this  to  mean  that  the  tax  applied  if  a  foreign  corporation  was 
either  doing  business  or  had  capital  invested  here  and  held  that 
money  invested  in  the  securities  of  American  corporations  was 
capital  invested  in  the  United  States  regardless  of  the  domicile  of 
the  securities  or  that  of  the  corporation  owning  them.  (Letter 
from  Treasury  Department  dated  June  6,  1916;  I.  T.  S.  1917, 
H  1505.)  In  DeGanay  v.  Lederer,  239  Fed.  5(58,  it  was  held  that 
the  income  tax  properly,  applied  to  income  on  domestic  securities 
owned  by  a  non-resident  alien,  which  securities  were  kept  in  this 
country. 


FOREIGN    CORPORATIONS  185 

Deductions  from  Gross  Income  Allowed  by  Law.  The 
ileductious  from  the  gross  income  of  a  foreign  corpora- 
tion should  as  nearly  as  possible  represent  the  actual  ex- 
penses and  authorized  charges  incident  to  the  income  de- 
rived from  this  country  and  must  not  comprehend  either 
directly  or  indirectly  any  expenditures  or  charges  in- 
curred in  the  transaction  of  business  or  the  investment 
or  capital  without  the  United  States.*'  The  principle 
followed  by  the  Treasury  Department  is  that  all  allow- 
able deductions  shall  be  computed  upon  a  basis  which 
recognizes  that  the  income  arising  and  accruing  from 
business  done  in  and  from  this  country  shall  bear  its 
share,  and  no  more,  of  expense  incident  to  the  earning 
or  creation  of  such  income  in  the  ratio  that  the  gross 
income  arising  in  and  from  this  country  bears  to  the  en- 
tire gross  income  arising  from  business  done  both  within 
and  without  this  country.*' 

When  Income  Is  Derived  from  Investments  Only. 
A  corporation  deriving  its  sole  income  from  this  country 
in  the  form  of  dividends  or  interest  on  domestic  stocks 
and  bonds  is  permitted  to  deduct  from  the  income  so 
received  such  items  of  disbursement,  loss,  etc.,  as  would 
be  properly  deductible  were  the  income  derived  from  any 
other  source.  The  deduction  shall  comprehend  only  such 
expenditures,  losses,  etc.,  as  are  incurred  in  or  are  in- 
cidental to  the  creation  of  the  income  against  which  they 
are  charged  and  in  all  cases  the  amounts  must  be  within 
the  limits  fixed  by  law.^® 

UReg.  33,  Art.  157. 

19  Letter  from  Treasury  Dep»rtment  dated  July  18,  1916; 
I.  T.  S.  1917,  1 1114. 

80  Letter  from  Treasury  Department  dated  .fune  6,  1916; 
I.  T.  S.  1917,  11505. 


186  FEDERAL   INCOME   TAX 

Ordinary  and  Necessary  Expenses.  A  foreign  cor- 
poration may  deduct  all  the  ordinary  and  necessary  ex- 
penses actuaEy  paid  within  the  year  out  of  earnings  in 
the  maintenance  and  operation  of  its  business  and  prop- 
erty within  the  United  States,  including  rentals  or  other 
payments  required  to  be  made  as  a  condition  to  the  con- 
tinued use  or  possession  of  property  to  which  the  cor- 
poration has  not  taken  or  is  not  taking  title,  or  in  which 
it  has  no  equity.  This  chapter  contains  only  the  rulings 
applicable  to  foreign  corporations.  The  chapter  on  do- 
mestic corporations  should  be  read  as  well  as  the  chapteris 
discussing  the  general  provisions  relating  to  deductions. 
Where  certain  expenses  such  as  coal,  ships  stores,  etc., 
in  the  case  of  foreign  steamship  companies,  cannot  be 
segregated  the  total  expenses  of  the  foreign  corporation 
for  such  items  should  be  pro-rated  in  such  proportion  as 
the  gross  income  of  the  corporation  from  sources  within 
the  United  States  bears  to  the  gross  income  derived  from 
all  sources  both  within  and  without  the  United  States, 
that  is  to  say,  if  one-half  of  the  gross  income  of  the  for- 
eign corporation  is  from  this  country  one  half  of  such 
expenses  would  be  proper,  deduction.*^^ 

Losses.  All  losses  actually  sustained  within  the  year 
in  business  or  trade  conducted  by  the  foreign  corporation 
within  the  United  States  and  not  compensated  by  in- 
surance or  otherwise  may  be  deducted  including  a  rea- 
sonable allowance  for  the  exhaustion,  wear  and  tear  of 
property  arising  out  of  its  use  or  employment  in  the 
business  or  trade,  within  the  limits  permitted  to  domestic 
corporations.  It  should  be  noted  that  losses  which  may 
be  deducted  are  those  sustained  in  the  business  conducted 

21  T,  D.  1675;  Keg.  33,  Art.  116;  Letter  from  Treasury  Depart 
ment  dated  December  8,  1916. 


FOREIGN    CORPORATIONS  187 

ill  tlie  United  States  and  depreciation  may  be  deducted 
only  on  property  used  in  connection  with  such  business. 
The  general  rulings  relating  to  losses  and  depreciation 
are  discussed  in  the  chapters  on  deductions.**  No 
rulings  or  decisions  especially  applicable  to  foreign  cor- 
porations have  been  made  with  reference  to  these  deduc- 
tions. 

Depletion  op  Natural  Resources.  Foreign  corpora- 
tions owning  mines  or  oil  and  gas  wells  in  this  country 
are  entitled  to  the  same  allowances  for  depletion  of  the 
natural  resources  as  are  permitted  to  domestic  corpora- 
tions and  individuals.  For  a  discussion  of  these  allow- 
ances see  the  chapters  on  depletion.** 

Deductions  prom  Income  op  Foreign  Insurance 
<  ompanies.  The  special  deductions  allowed  in  the  case 
of  insurance  companies,  domestic  and  foreign,  are  treated 
in  the  foregoing  chapter. 

Interest.  Foreign  corporations  are  permitted  to  de- 
duct a  part  of  the  interest  paid  during  the  year  under 
the  following  rules.  The  amount  of  indebtedness 
on  which  the  interest  may  be  deducted  must  be  an 
amount  not  in  excess  of  the  entire  amount  of  the  paid 
up  capital  stock  outstanding  at  the  close  of  the  year,  or 
if  no  capital  stock,  the  entire  amount  of  the  capital  em- 
ployed in  the  business  at  the  close  of  the  .tear  plus  one 
half  of  its  interest  ^bearing  indebtedness  then  outsrtand- 
ing,  that  is  to  say.  the  greatest  amount  of  interest  which 
,0.  foreign  corporation  can  deduct  is  limited  in  the  same 
way  as  in  the  ca.se  of  doii\estic  corporations.     The  <lis- 

88  See  Chapters  31  and  32. 
WSee  Chapters  33  and  34. 


188  FEDERAL   INCOME   TAX 

eussioii  of  this  limitation  in  the  Chapter  on  Corporations 
applies  equally  to  domestic  and  foreign  corporations.^* 
If  the  foreign  corporation  does  all  its  business  in  the 
United  States  the  interest  on  the  amount  of  indebtedness 
ascertained  as  above  may  be  deducted.  If  it  does  only  a 
part  of  its  business  in  the  United  States  there  may  be 
deducted  only  the  interest  paid  on  such  proportion  of 
the  amount  of  indebtedness  ascertained  as  above  as  the 
gross  amount  of  its  income  for  the  year  from  business 
transacted  and  capital  invested  within  the  United  States 
bears  to  the  gross  amount  of  its  income  derived  from  all 
sources  within  and  without  the  United  States.  As  in  the 
case  of  all  other  taxpayers,  foreign  corporations  are  not 
permitted  to  deduct  the  amount  of  interest  on  indebted- 
ness incurred  for  the  purchase  of  obligations  or  securities 
the  interest  upon  which  is  exempt  from  the  income  tax. 

Interest  on  Indebtedness  Secured  by  Collateral. 
The  provision  of  law  permitting  a  deduction  to  domestic 
corporations  of  the  full  amount  of  interest  paid  on  in- 
debtedness secured  by  collateral  the  subject  of  sale  or 
liypothecation  in  the  ordinary  business  of  the  corpora- 
tion is  not  allowed  by  the  law  to  foreign  corporations. 

Interest  Paid  by  Banks  on  Deposits.  A  foreign 
bank,  banking  association,  loan  or  trust  company,  or 
branch  thereof,  may  deduct  in  full  the  interest  paid 
within  the  year  on  deposits  by  or  on  moneys  received  for 
investment  from  either  citizens  or  residents  of  the  United 
States  and  secured  by  interest-bearing  certificates  of 
indebtedness  issued  by  such  bank,  bank  association,  loan 
or  trust  company  or  branch  thereof.  Interest  so  paid 
to  citizens  and  residents  being  taxable  as  income  to  them 

24  See  Chapter  12. 


POKEIGN    COKPORATIONS  18^ 

IS  properly  deductible  from  the  income  of  the  foreigu 
corporation. 

Taxes.  A  foreign  corporation  may  deduct  taxes  paid 
within  the  year  imposd  by  the  authority  of  the  United 
States  (except  income  and  excess  profits  taxes)  or  its 
territories  or  possessions  or  under  the  authority  of  any 
state,  county,  school  district  or  municipality  or  other 
subdivision  of  any  state,  paid  within  the  United  States, 
not  including  those  assessed  against  local  benefits.  This 
allowance  for  taxes  is  the  same  as  that  allowed  to  do- 
mestic corporations  and  to  individuals  except  that  it  is 
expressly  limited  to  cases  where  the  tax  is  assessed  by 
a  governmental  authority  within  the  jurisdiction  of  the 
United  States  and  the  tax  paid  within  the  United  States. 
For  a  general  discussion  of  the  extent  to  which  taxes  may 
be  deducted  see  the  Chapter  on  Deduction  of  Taxes.*^ 

Duty  of  Foreign  Corporations  in  Pajnng  Out  Income. 

Where  a  resident  alien  corporation  pays  out  income  to 
others  subject  to  the  tax  it  is  subject  to  all  the  duties 
and  responsibilities  imposed  upon  domestic  corporations 
as  to  withholding  the  tax  at  the  source  or  reporting  the 
names  of  the  persons  to  whom  such  income  is  paid.  For 
a  further  discussion  of  this  subject  see  the  Chapter  on 
Collection  at  the  Source  and  the  Chapter  on  Information 
at  the  Source.  Non-resident  alien  corporations  are  under 
no  duty  in  paying  out  net  income  to  others  whether  or 
not  such  payees  are  citizens  or  residents  of  this  country. 

Return  of  Annual  Net  Income.  Foreign  corporations 
•I'M-iving  income  from  sources  within  this  country  are 

^5  See  Chapter  30. 


190  FEDERAL   INCOME   TAX 

required  to  file  a  return  of  annual  net  income  in  the  same 
manner  as  required  of  domestic  corporations,  and  the 
Chapter  on  Corporations  should  be  read  in  this  con- 
nection,^^ 

When  Filed.  A  foreign  corporation  may  file  its  re- 
turn for  the  calendar  year,  on  or  before  March  1  of  the 
year  following,  or  may  duly  designate  a  fiscal  year  in 
the  manner  indicated  in  the  Chapter  on  Corporations, 
and  file  its  return  within  sixty  days  after  the  close  of 
such  fiscal  year.  The  time  for  filing  returns  of  foreign 
corporations  may  be  extended  as  stated  in  the  chapter 
containing  the  general  provisions  relating  to  returns.^''' 

"Where  Filed.  The  return  is  filed  in  the  case  of  a 
foreign  corporation  in  the  office  of  the  collector  of  the 
district  in  which  is  located  its  principal  place  of  busi- 
ness in  the  United  States,  or  if  it  has  no  principal  place 
of  business,  office,  or  agency  in  the  United  States,  then 
in  the  office  of  the  Collector  of  Internal  Revenue  at  Balti- 
more, Maryland.  Where  returns  for  a  foreign  corpora- 
tion are  filed  by  an  agent  in  this  country,  the  place  of 
filing  is  the  office  of  the  collector  of  the  district  in  which 
the  agent  has  his  place  of  business  or  residence. 

By  Whom  Filed.  The  responsibility  for  filing  the 
return  rests  in  some  cases  on  the  agent  of  the  foreign 
corporation  in  this  country  as, indicated  in  the  Chapter 
on  Agents  for  Non-resident  Aliens  and  Foreign  Cor- 
porations. When  the  return  is  filed  by  the  officers  of 
the  corporation  the  agent  of  the  corporation  in  this 
country  is  relieved  of  responsibility.     As  to  the  filing  of 

28  See  Chapter  12. 
27  Rfie  Chapter  35. 


POREIIGN    CORPORATIONS  191 

it'turus  ill  the  case  of  bankruptcy  or  dissolution  8ee< 
1 1 10  Chapter  on  Corporations.  Foreign  corpora tioijs 
having  several  branch  offices  in  the  United  States  should 
designate  one  of  such  branches  as  the  principal  office  an.d 
should  also  designate  the  proper  officer  to  make  the 
required  return.**  Agents  for  foreign  steamship  com- 
panies may  sign  the  required  returns  if  so  authorized  by 
their  companies. 

How  Prepared.  The  return  is  prepared  in  the  same 
manner  as  returns  by  domestic  corporations  except  that 
the  statements  should  relate  to  income  from  sources 
within  this  country  and  the  deduction  should  be  limited 
as  above  indicated.  As  to  the  general  requirements  to 
be  observed  in  preparing  the  return  see  the  Chapter  on 
Corporations. 

How  Signed  and  Sworn  To.  In  case  the  return  is 
filed  by  the  home  offioe  of  the  corporation  it  should  be 
sworn  to  by  the  president,  vice-president  or  other  princi- 
f>al  officer  and  by  the  treasurer  or  assistant  treasurer  and 
lii>  verified  in  the  same  manner  as  ref^uired  in  the  case 
of  domestic  corporations.  As  to  the  general  provisions 
respecting  the  oath  or  affirmation  see  the  Chapter  on 
Reports.^  Where  the  return  is  signed  by  the  agent  for 
the  corporation,  resident  in  this  country,  the  affidavit  on 
the  form  should  be  changed  to  show  that  the  report  ia 
made  by  such  agent  and  covers  all  the  income  coming 
into  his  hands,  or  all  the  income  of  the  corporation  from 
sources  within  the  United  States,  as  the  case  may  be. 

Special  Returns  by  Corporations.  Resident  alien  cor- 
porations are  required  to  make   the  same  special   re- 

a«  Reg.  33,  Art.  83. 
»See  Chapter  35. 


192  FEDERAL   INCOME   TAX 

turns  as  domestic  corporations.  Non-resident  alien 
corporations  are  not  required  to  make  special  returns 
by  any  express  provision  of  the  law,  but  may  be  called 
upon  under  general  provisions  of  the  law  for  informa- 
tion respecting  their  income  from  sources  within  this 
country. 


CHAPTER  15 

EXEMPT    CORPORATIONS 

Section  11  of  the  1916  Law  expressly  exjempts  four- 
teen classes  of  corporations  from  the  tax.  The  first 
eight  of  these  classes  were  exempt  under  the  1913  Law, 
the  last  six  classes  were  added  by  the  1916  Law.  Exempt 
corporations  under  the  1913  Law  were  exempt  -from  all 
provisions  of  the  law,  and  it  was  held  that  this  included 
exemption  from  the  duty  of  acting  as  withholding  agent. 
The  exemption  of  the  1916  Law  is  limited  to  the  tax 
and  to  the  making  of  the  return  of  annual  net  income.* 
Exempt  corporations  are  now  required  to  withhold  the 
tax  at  the  source  and  to  report  payments  of  income  to 
others,  in  the  same  manner  as  is  required  of  taxable 
corporations.*  Corporations  exempt  under  the  1916  Law 
are  also  exempt  to  the  same  extent  under  the  1917  Law. 

Foreign  Corporations.  The  provisions  of  Section  11 
of  the  1916  Law  are  held  to  apply  to  foreign  corpora- 
tions as  well  as  to  domestic  corporations,  except  as  to 
building  and  loan  associations  and  co-operative  banks. 
In  case  a  foreign  organization  desires  to  be  held  exempt 
from  the  law,  and  a  doubt  exists  as  to  whether  or  nof 
it  comes  within  the  class  of  organizations  enumerated 
in  Section  11,  it  will  be  required  to  file  a  copy  of  its 

1  Act  of  September  8,  1916,  S  13. 
«T.  D.  2407. 

193 
F.  I.  Tax.— 13 


194:  FEDERAL   INCOME  TAX 

Charter  and  By-laws  and  an  affidavit  executed  by  its 
principal  officer  showing  the  disposition  made  of  such 
income  as  it  receives  and  stating  specifically  whether  or 
not  any  of  the  income  so  received  inures  to  the  benefit  of 
any  individual  stockholder.  The  question  of  whether 
or  not  the  organization  will  be  held  to  be  exempt  is  de- 
termined by  the  Treasury  Department  upon  the  facts  so 
shown.^ 

Exemption  Limited  to  Classes  SpecificaJly  Enumer- 
ated. Any  corporation,  no  matter  hoAv  created  or  or- 
ganized, or  what  the  purposes  of  its  organization  may  be, 
is  taxable  unless  it  comes  within  the  classes  of  organiza- 
tions specifically  enumerated  as  exempt.  A  corporation 
is  not  exempt  simply  and  only  because  it  is  primarily  not 
organized  and  operated  for  profit.  If  income  within  the 
meaning  of  the  law  arises  and  accrues  to  a  corporation, 
such  income  will  be  subject  to  the  tax  unless  it  is  one 
of  the  exempt  organizations  expressly  enumerated  in 
Section  11.  Thus,  commercial  men's  associations,  and 
like  organizations  are  not  exempt,  as  they  are  not  ex- 
pressly enumerated,  although  they  may  be  corporations " 
not  organized  for  profit.* 

Where  Question  as  to  Right  of  Exemption  Exists. 

Where  there  is  any  doubt  as  to  the  status  of  a  corpora- 
tion under  the  provisions  of  the  law,  and  its  exempt 
status  has  not  been  established  by  the  Treasury  Depart- 
ment, the  annual  return  should  be  filed   (in  blank  if 

8  Letter  from  Treasury  Department  dated  December  6,  1916; 
I.  T.  8.  1917,  f  1134. 

4  Reg.  33,  Art.  80;  T.  D.  2152.  This  Treasury  decision  also 
held  farmers'  mutual  fire  hisurance  companies  to  be  taxable,  but 
the  1916  Law  subsequently  expressly  exempted  such  organizations 


EXEMPT   CORPORATIONS  195 

desired)  and  an  affidavit  attached  thereto  setting  out 
fully  the  nature  and  purpose  of  the  organization,  the 
source  of  its  income  and  what  disposition  is  made  of 
it  and  particularly  of  any  surplus.* 

Right  of  Exemption  Must  Be  Proved  on  Request. 

.Corporations  enumerated  as  exempt  may  at  the  request 
of  the  Collector  or  Commissioner  of  Internal  Revenue, 
be  required  to  establish  their  right  by  showing  the  char- 
acter and  purpose  of  the  organization,  the  manner  of 
distributing  the  net  income,  if  any,  or  that  none  of  the 
net  income  inures  to  the  benefit  of  any  private  stock- 
holder or  individual.  In  the  absence  of  such  a  showing 
such  organizations  may  at  any  time  be  required  to 
make  returns  of  annual  net  income  or  disclose  their 
books  of  account  to  a  revenue  officer  for  examination  in 
order  that  the  status  of  the  company  may  be  determined.® 
Having  once  satisfied  the  collector  as  to  its  right  to 
exemption  a  corporation  is  not  required  to  make  any 
further  showing  in  subsequent  years  unless  the  col- 
lector has  reason  to  believe  that  the  status  of  the  organ- 
ization has  changed,  or  that  its  net  income  is  inuring 
to  tlie  benefit  of  th<^  stockholders  or  members.'' 

Labor,  Agricultural  and  Horticultural  Organizations 
(first  class).  Although  the  law  exempts  these  organ- 
izations without  any  qualification,  the  exemption  is  un- 
doubtedly intended  to  apply  only  to  such  organizations 
as  are  not  organized  for  profit  but  are  organized  for 
the  mutual  welfare  of  their  membei*s.    Thus  agricultural 

6  Reg.  33,  Art.  91;  Letter  from  Treasury  Department  dated 
November  1,  1916;  I.  T.  S.  1917,  K  1133. 

«Reg.  33,  Art.  88. 

7  Mimeograph  letter  to  CoUeotors  No.  1148. 


196  FEDERAL  INCOME  TAX 

corporations  owing  sugar  plantations  and  disposing  of 
the  product  thereof  have  been  held  by  the  Treasury  De- 
partment to  be  organized  for  profit  and  not  entitled  to 
exemption  as  agricultural  organizations  under  this  pro- 
vision,^  County  fairs  or  like  organizations  not  them- 
selves engaged  in  agricultural  or  horticultural  pursuits, 
but  which,  by  means  of  awards,  premiums,  etc.,  are  in- 
tended to  encourage  better  production,  and  no  part  of 
whose  income  inures  to  the  benefit  of  any  private  stock- 
holder or  individual,  are  held  to  be  exempt.* 

Mutual  Savings  Banks  (second  class).  The  mutual 
savings  banks  which  are  exempt  are  those  not  having  a 
capital  stock  represented  by  shares.  As  to  what  consti- 
tutes a  mutual  purpose  see  the  discussion  in  the  para- 
graph on  building  and  loan  associations  below. 

Fraternal  Beneficiary  Societies  (third  class).  Fra- 
ternal beneficiary  societies,  orders  or  associations  are 
exempt  if  they  operate  under  the  lodge  system  or  if 
they  are  for  the  exclusive  benefit  of  the  members  of  a 
fraternity  itself  operating  under  the  lodge  system,  and 
if  they  provide  for  the  payment  of  life,  sick,  accident, 
or  other  benefits  to  the  members  of  such  society,  order 
or  association  or  their  dependents.  One  important  char- 
acteristic of  this  class  of  exempt  corporations  is  that 
they  must  operate  under  the  lodge  system  or  be  for  the 
exclusive  benefit  of  a  society  operating  under  such  sys- 
tem. Such  a  society  or  organization  is  considered  to  be 
one  organized  under  a  charter,  with  properly  appointed 
or  elected  officers,  with  an  adopted  ritual  or  ceremonial, 
holding  meetings  at  stated  intervals,  and  supported  by 

8T.  D.  2090. 
9T.  B.  1737. 


EXEMPT  CORPORATIONS  197 

fees,  dues  or  assessments.^'*  Mutual  protective  associa- 
tions, not  operating  under  a  lodge  system  are  not  exempt 
under  this  provision  since  they  lack  one  of  the  charac- 
.teristics  of  this  class.^* 

Domestic  Buildinsc  and  Loan  Associations  and  Co- 
operative Banks  "  (fourth  class).  A  domestic  building 
and  loan  association  is  held  to  be  one  organized  under 
the  laws  of  the  United  States  or  of  a  state  or  territory  or 
under  the  laws  applicable  to  Alaska  or  the  District  of 
Columbia.  Mutuality  in  operation  and  in  the  distribu- 
tion of  profits  and  benefits  is  essential  to  exemption  In 
order  to  come  within  the  exempted  class  such  associations 
must  not  only  be  domestic  but  they  must  be  without  capi- 
tal stock  and  be  organized  and  operated  exclusively  for 
mutual  purposes  and  without  profit;  that  is,  all  the 
profits  and  benefits  provided  for  in  the  articles  of  asso- 
ciation and  by-laws  must  be  ratably  distributed  among 
all  the  members,  regardless  of  the  kind  of  stock  held, 
according  to  the  amount  of  money  they  have  on  deposit. 
An  association  issuing  different  classes  of  stock  upon 
which  different  rates  of  interest  or  dividends  are  guar- 
anteed or  paid  is  not  in  the  exempt  class.*'  Under  the 
1909  Law  it  was  decided  that  a  building  and  l^an  asso- 
ciation was  exempt  although  it  issued  both  prepaid  and 
instalment  stock,  but  that  one  issuing  preferred  stock 
was  not  exempt.**    Mutual  benefit  does  not  necessarily 

10  Reg.  33,  Art.  89. 

11  Commercial  Travelers  Life  and  Accident  Association  v.  Rod- 
way,  235  Fed.  370.  This  case  contains  an  extended  diseuas'on  on 
the  distinction  between  a  mutual  association  and  a  fraternal  asso- 
ciation. 

18  Co-operative  banks  were  included  by  the  1916  Law. 

13  Reg.  33,  Art:  87. 

14  Pacific  BIdg.  ft  Loan  Alss'n  v.  Hart«on,  201  Fed.  1011. 


198  FEDERAL   INCOME  TAX 

mean  equal  benefit.  A  building  and  loan  association  is 
organized  and  operated  for  the  mutual  benefit  of  its 
members  when  they  share  in  the  profits  on  substantially 
the  same  footing.  Exact  equality  is  probably  not  pos- 
sible where  part  of  the  stock  is  prepaid  and  part  is 
instalment,  but  an  approximate  equality  sufficiently  close 
for  aU  purposes  is  certainly  not  beyond  the  reach  of 
calculation.*®  Building  and  loan  associations  are  not 
exempt  if  they  loan  money  to  others  than  their  members, 
thus  doirg  business  similar  to  that  engaged  in  by  banks 
or  trust  companies.  Building  and  loan  associations 
which  receive  sums  of  money  on  deposit  which  is  not 
payment  of  stock,  and  on  which  the  depositor  receives 
a  fitxed  rate  of  interest,  regardless  of  the  earnings  of 

16  Herold  v.  Parkview  Building  and  Loan  Associat'on,  210  Fed. 
577.  The  association  issued  two  varieties  of  stock,  one  known 
as  prepaid  stock  on  which  the  full  par  value  of  $200  per  share 
was  paid  by  the  holder  at  the  time  of  the  is-^uance  of  the  stock, 
and  upon  which  the  Company  paid  to  the  holder  out  of  the  profits 
of  the  association  the  sum  of  5%  per  annum  in  lieu  of  partic'pa- 
tion  by  said  stockholder  in  the  general  profits  of  the  association, 
and  a  second  stock  known  as  instalment  stock  whereon  the  holder 
paid  one  dollar  per  share  per  month  and  to  which  was  added  the 
proportionate  share  of  the  profits  of  the  assoe'ation  after  deduct- 
ing expenses  until  the  aggregate  of  payments  and  profits  equaled 
the  sum  of  $200,  when  the  saM  sum  was  paid  to  the  holder  and 
the  shares  retired.  The  prepaid  stock  could  be  cancelled  by  the 
corporation  at  any  time  upon  thirty  days'  notice  and  payment  of 
the  value  thereof  together  with  interest  at  the  rate  of  5%  from 
the  date  of  last  payment  of  interest,  and  each  holder  of  such 
stock  could  likewise  upon  thirty  days'  notice  tender  h^s  certificate 
and  require  payment  from  the  association.  The  association  bor- 
rowed no  money  from  individuals  whether  members  or  non- 
members,  loaned  no  money  to  persons  other  than  members  of  the 
association,  but  borrowed  according  to  its  business  demands  from 
a  local  bank.  The  association  was  organized  tinder  the  Act  of 
April  8,  1903  (Public  Laws,  p.  457)  of  New  Jersey. 


EXEMPT  CORPORATIONS  199 

the  association,  are  conducting  a  business  similar  to 
a  banking  business,  and  are  therefore  subject  to  the 
tax,^*  unless  they  fall  within  the  class  of  co-operative 
banks. 

Cemetery  Companies  (fifth  class).  A  cemetery  com- 
pany is  exempt  if  it  is  owned  and  operated  exclusively 
for  the  benefit  of  its  members.  Companies  which  operate 
cemeteries  for  profit  are  not  exempt.*'' 

Religious,  Charitable,  Scientific  and  Educational  Or- 
ganizations (sixth  class).  Corporations  or  associations 
organized  and  operated  exclusively  for  religious,  charit- 
able, scientific  or  educational  purposes  are  exempt  if  no 
part  of  the  net  income  accruing  to  the  association  inures 
to  the  benefit  of  any  private  stockholder  or  individual. 

Business  Associations  (seventh  class).  Business 
leagues,  chambers  of  commerce  and  boards  of  trade,  not 
organized  for  profit  and  no  part  of  the  net  income  of 
which  inures  to  the  benefit  of  any  private  stockholder  or 
individual  are  exempt.  It  will  be  noted  that  only  three 
kinds  of  business  associations  are  enumerated  in  this 
section  and  as  the  law  is  strictly  construed  as  to  exemp- 
tions other  business  associations  would  not  be  exempt 
even  though  organized  not  for  profit. 

Civic  Organizations  (eighth  class).  Civic  leagues  or 
organizations  not  organized  for  profit  but  operated  ex- 
clusively for  the  promotion  of  social  welfare  are  exempt. 

Clubs  (ninth  class).  Clubs  organized  and  operated 
exclusively  for  pleasure,  recreation  and  other  non-profit- 

1«  T.  D.  1655. 

"  Reg.  33,  Art.  90. 


200  FEDERAL  INCOME  TAX 

able  purposes  are  exempt  if  no  part  of  the  net  income 
inures  to  the  benefit  of  any  private  stockholder  or  mem- 
ber.^* A  club  desiring  to  be  registered  as  exempt  should 
file  with  the  Commissioner  of  Internal  Revenue  a  copy 
of  its  charter  or  an  affidavit  of  its  principal  officer  setting 
forth  the  nature  of  its  organization,  the  purpose  for 
which  it  was  organized,  the  source,  if  any,  from  which 
it  derives  income,  and  the  disposition  made  of  such  in- 
come.^® It  should,  in  addition  to  the  disposition  of  its 
income,  particularly  show  any  surplus,  and  whether  or 
not  such  surplus  will  ever  inure  to  the  benefit  of  any 
private  stockholder  or  individual.^** 

Club — Accumulating  Christmas  Fund.  An  incor- 
porated club,  composed  of  the  employees  of  a  corpora- 
tion, was  organized  for  social  purposes.  The  only  source 
of  income  of  the  club  was  the  initiation  fee,  and  this 
was  expended  solely  for  entertainments.  Certain  mem- 
bers, called  participating  members,  made  contributions 
to  a  "Christmas  Fund,"  which  fund  was  invested  by 
the  executive  committee  of  the  club  as  it  saw  fit.  Shortly 
before  Christmas  in  each  year  the  investments  were 
liquidated  and  the  net  fund  distributed  to  the  participat- 
ing members  in  proportion  to  their  contributions.  It 
was  held  that  the  club  was  organized  and  operated  ex- 
clusively for  pleasure,  recreation  and  other  non-profit- 
able purposes  and  that  no  part  of  its  net  income  inured 
to  the  benefit  of  any  private  stockholder  or  member.    The 

18  Such  clubs  were  held  to  be  exempt  under  the  1913  Law, 
although  that  law  did  not  contain  the  express  exemption  which 
appears  in  the  1916  Law.  (Letter  from  Treasury  Department 
dated  March  4,  1914;  I.  T.  S.  1917,  111144.) 

19  T.  D.  2090. 

20  Letter  from  Treasury  Department  dated  February  12,  1916; 
L  T.  8.  1917;  H  1146. 


J 


EXEMPT  CORPORATIONS  201 

fact  that  the  executive  committee  received  specific  dues 
from  certain  members,  to  be  invested  in  various  ways 
and  thereby  derived  income  did  not  take  it  out  of  the 
exempt  class,  since  the  funds  so  received  were  not  the 
property  of  the  club  and  were  returned,  together  with 
the  profit  thereon,  to  the  contributing  members.** 

Mutual  or  Co-operative  Organizations  of  a  Local 
Character  (tenth  class).  Farmers'  or  other  mutual  hail, 
cyclone  or  fire  insurance  companies,  mutual  ditch  or 
irrigation  companies,  mutual  or  co-operative  telephone 
companies,  and  like  organizations  of  a  purely  local  char- 
acter, the  income  of  which  consists  solely  of  assessments, 
dues  and  fees  collected  from  members,  for  the  sole  pur- 
pose of  meeting  expenses,  are  exempt.  It  should  be 
noted  that  the  essential  features  of  this  class  are  as 
follows:  (a)  They  must  be  mutual  or  co-operative;  (b) 
they  must  be  of  a  purely  local  character;  (c)  the  income 
must  be  solely  from  assessments,  dues  and  fees  collected 
from  members,  and  such  assessments,  dues  and  fees  must 
be  used  for  the  sole  purpose  of  meeting  expenses. 

Co-operative  Dairies.  Under  the  1913  Law  which 
did  not  contain  the  foregoing  exemption  it  was  held  that 
co-operative  dairy  associations,  whether  issuing  capital 
stock  or  not,  were  not  exempt  as  agricultural  organiza- 
tions. In  the  preparation  of  their  returns  such  associa- 
tions were  permitted  to  decTuct  from  gross  income  the 
amount  actually  paid  to  members  and  patrons  for  milk, 
but  any  amount  retained  at  the  end  of  the  year  over 
and  above  expenditures  was  taxable  as  income.**  This 
would  hold  true  under  the  foregoing  exemption,  but  co- 

21  Letter  from  Treasury  Department  dated  January  12,  1917. 
w  T.  D.  1996. 


202  FEDERAL   INCOME  TAX 

operative  dairy  associations  are  now  exempt  if  they  have 
the  characteristics  indicated  in  the  preceding  paragraph. 

Associations  for  Marketing  Produce  (eleventh  class). 

Farmers',  fruit  growers'  or  like  associations,  organized 
and  operated  as  sales  agents  for  the  purpose  of  market- 
ing the  products  of  its  members  and  turning  back  to 
them  the  proceeds  of  sales,  less  the  necessary  selling  ex- 
penses, on  the  basis  of  the  quantity  of  produce  furnished 
by  them,  are  exempt. 

Corporations  Owned  by  Exempt  Corporations 
(twelfth  class).  Corporations  or  associations  organized 
for  the  exclusive  purpose  of  holding  title  to  property, 
collecting  income  therefrom,  and  turning  over  the  entire 
amount  thereof,  less  expenses,  to  organizations  which 
are  themselves  exempt  from  the  income  tax  are  also 
ejfempt.  Such  corporations  were  held  to  be  taxable  un- 
der the  1913  Law  in  the  absence  of  an  express  provision 
in  that  law  for  their  exemption.^' 

Federal  Land  Banks  and  National  Farm-Loan  Asso- 
ciations (thirteenth  class).  Such  banks  and  associations 
as  provided  in  Section  26  of  the  Act  of  July  17,  1916, 
entitled  ''An  act  to  provide  capital  for  agricultural  de- 
velopment, to  create  standard  forms  of  investment  based 
upon  farm  mortgage,  to  equalize  rates  of  interest  upon 
farm  loans,  to  furnish  a  market  for  United  States  bonds, 
to  create  Government  depositaries  and  financial  agents 
for  the  United  States,  and  for  other  purposes,"  are 
exempt. 

Joint  Stock  Land  Banks  (fourteenth  class).  Such 
banks  are  exempt  as  to  income  derived  from  bonds  or 


88  T.  D.  2137. 


I 


EXEMPT  CORPORATIONS  203 

debentures  of  other  joint  stock  land  banks  or  any  federal 
land  bank  belonging  to  such  joint  stock  land  bank.  They 
are  taxable,  however,  as  to  income  from  other  sources 
and  consequently  it  would  seem  are  not  exempt  from 
the  requirement  of  making  a  return  of  annual  net  in- 
come since  the  exemption  from  making  returns  applies 
only  to  corporations  not  subject  to  the  tax.^* 

Income  Accruing  to  State  or  Local  Governments.    In 

addition  to  the  fourteen  exemptions  noted  above  Section 
11  of  the  1916  Law  provides  that  income  shall  not  be 
taxed  if  it  is  derived  from  any  public  utility  or  from 
.  the  exercise  of  any  essential  governmental  function  and 
accrues  to  any  state,  territory  or  the  District  of  Columbia 
or  any  political  subdivision  of  a  state  or  territory.  It 
alse  provides  that  no  income  accruing  to  the  government 
of  the  Philippine  Islands  or  Porto  Rico  or  the  govern- 
ment of  any  political  subdivision  of  those  possessions 
shall  be  taxed.  Where  a  state,  territory  or  the  District 
of  Columbia,  or  any  political  subdivision  of  a  state  or 
territory,  has  prior  to  the  passage  of  the  law  entered  into 
a  contract  with  any  person  or  corporation  to  acquire, 
construct,  operate  or  maintain  a  public  utility  no  tax 
is  levied  upon  the  income  derived  from  the  operation  of 
such  public  utility  so  far  as  the  payment  thereof  will 
impose  a  loss  or  burden  upon  such  state,  territory  or 
district  or  political  subdivision.  This  provision  entitles 
the  owner  of  such  public  utility,  whether  a  person  or  a 
corporation,  to  deduct  the  amount  of  income  paid  to 
the  state  or  local  government  as  its  share,  and  the  rulings 
thereon  are  contained  in  the  chapters  on  Deductions.** 

M  Act  of  September  8,  1916,  8  13,  %  (b). 
M  See  Chapter  28. 


204  FEDERAL,  INCOME  TAX 

Federal  Reserve  Banks.  The  income  of  Federal  Re- 
serve Banks  is  exempt  from  income  tax  by  express  pro- 
vision in  the  Federal  Reserve  Act.^®  The  dividends  on 
the  stock  of  such  banks  are  exempt  from  tax  in  the 
hands  of  member  banks.^''^ 

26  Federal  Beserve  Act,  38  Stat.  251,  Ch.  6,  §  7. 

27  Federal  Reserve  Bulletin,  April  1,  1916. 


CHAPTER  16 

INCOME — IN   GENERAL 

A  discussion  of  the  various  conceptions  of  income 
would  be  interesting  but  is  out  of  place  in  a  work  of 
this  character.  For  all  practical  purposes  it  is  sufficient 
to  state  that  the  income  which  is  taxable  under  the 
present  laws  is  defined  in  the  statute.  One  conception 
of  income  excludes  gains  or  increment  in  the  value  of 
capital  assets,  but  this  conception  was  not  that  of  Con- 
gress, since  the  tax  is  not  only  upon  income  conceived  as 
a  production  of  capital,  but  also  upon  gains  and  profits 
derived  from  sales  or  dealings  in  property,  growing  out 
of  the  ownership  or  use  of  or  interest  in  property  or  from 
gains  or  profits  from  any  source  whatever.  For  the  pur- 
pose of  discussion  in  this  and  the  following  chapters,  the 
general  rules  and  principles  applicable  to  income  from 
all  sources  will  first  be  described,  and  thereafter^  Jhe 
special  rules  applicable  to  income  from  personal  services, 
income  from  farming,  income  from  business,  trade  and 
commerce,  income  from  dividends,  income  from  interest 
and  rent,  and  income  from  miscellaneous  sources.  The 
special  rules  relating  to  income  from  partnerships  and 
income  from  fiduciaries  are  treated  in  the  chapters  on 
those  respective  subjects. 

What  Constitutes  Income.  The  word  "income"  as 
used  in  revenue  legislation  has  a  settled  legal  meaning. 
The  courts  have  uniformly  construed  it  to  include  only 

205 


206  FEDERAL   INCOME   TAX 

the  receipt  of  actual  cash  as  opposed  to  contemplated 
revenue  due  but  unpaid,  unless  a  contrary  purpose  is 
manifest  from  the  language  of  the  statute.  What  wa« 
taxed  by  the  1909  Law  was  "net  income  received,"  not 
income,  accruing  or  accrued,  which  had  not  been  re- 
ceived and  portions  of  which  might  never  be  received. 
While  the  phrases  "income  received"  and  "income  ac- 
crued" are  frequently  used  in  the  same  statute,  the 
courts  have  not  departed,  unless  it  expressly  appears 
otherwise,  from  a  construction  of  the  law  in  accord  with 
an  intention  to  reach  the  actual  and  not  the  potential 
income.  In  the  1913  Law  the  two  preceding  phrases 
were  employed.  Doubtless  it  was  the  intention  of  Con- 
gress to  employ  terms  of  sufficient  comprehension  to 
reach  the  actual  income  by  foreclosing  any  possible  ave- 
nue of  escape,  but  it  can  hardly  be  said  that  in  so  doing 
an  intention  prevailed  to  tax  that  which  did  not  actually 
exist,  except  on  paper,  as  income  accrued  during  the 
taxing  period.  One  cannot  be  said  to  receive  an  income 
of  defined  proportions  until  he  balances  receipts  and  de- 
ductions at  the  end  of  a  stated  period  and  ascertains, 
not  what  is  due,  but  what  has  been  actually  received. 
The  assets  and  liabilities  may  be  measured  by  a  different 
rule  of  accounting,  but  income  as  defined  by  the  courts 
means,  as  said  in  United  States  v.  Schillinger,^  "in 
the  absence  of  any  special  law  to  the  contrary,  income 
must  be  taken  to  mean  money,  and  not  the  expectation 
of  receiving  it  or  the  right  to  receive  it  at  a  future 
time."  *  In  the  1916  Law  the  phrase  "income  received" 
is  used  with  respect  to  both  individuals  and  corpora- 
tions.* 

1 14  Blatch.  71. 

2  Maryland  Casualty  Co.  v.  U.  S.,  Ct.  Cls.,  T.  D.  2451. 

3  The  language  of  the  1909  Law  was  also  held  to  indicate  that 


INCOME — IN   GENERAL  207 

Actual  Receipts.  The  1916  Law  intends  primarily  to 
tax  individuals  and  corporations  upon  the  income  re- 
ceived, and  not  that  which  has  arisen  or  accrued,  but  has 
not  been  received.*  This  basis  of  actual  receipts  is  not 
exclusively  prescribed,  since  both  individuals  and  cor- 
porations may,  if  they  so  choose  and  the  Commissioner 
of  Internal  Revenue  permits  them,  report  their  net 
income  on  the  basis  of  accruals  instead  of  actual  receipts. 
This  provision  is  more  fully  discussed  in  subsequent 
paragraphs  of  this  chapter.  If  the  taxpayer  does  not 
elect  to  report  on  such  basis,  or  is  not  permitted  to  do 
so  by  the  Treasury  Department,  the  tax  must  be  com- 
puted on  the  ba.sis  of  actual  receipts.  An  early  ruling 
of  the  Treasury  Department,  under  the  1913  Law,  hold- 
ing that  a  person  receiving  fees  or  emoluments  for  pro- 
fessional services  must  include  all  actual  receipts  for 
services  rendered  in  the  year  for  which  the  return  was 
made,  together  with  all  unpaid  accounts,  charges  for 
services  or  contingent  income  due  for  that  year,  was  dis- 
cussed in  the  case  of  Edwards  v.  Keith,*  and  the  court 
said:  "No  such  construction  of  the  Treasury  Depart- 
ment can  enlarge  the  scope  of  the  statute  so  as  to  impose 
the  tax  upon  unpaid  charges  for  professional  services 
rendered,  which  for  aught  anyone  can  tell  may  never 
be  paid.  The  statute  alone  determines  what  is  income 
to  be  taxed.  It  taxes  only  income  derived  from  many 
specified  sources,  and  one  does  not  derive  income  by 
rendering  services  and  charging  for  them."     Accrued 

the  net  income,  which  was  the  measure  of  taxation,  meant  what 
had  actually  been  received  and  not  that  which,  although  due,  had 
not  been  received,  its  payment  for  any  reason  having  been  deferred 
or  postponed.  (Mutual  Benefit  Life  Insurance  Company  v. 
Herold,  198  Fed.  199.) 

*Act  of  September  8,  1916,  S  1  and  *  10. 

6  2.31  Fed.  110. 


208  FEDERAL  INCOME  TAX 

but  unpaid  interest  on  investments  has  been  held  not 
to  be  income.®  Under  the  broader  language  of  the  1909 
Law  it  was  held  that  income  was  taxable  only  to  the  ex- 
tent that  it  was  actually  received  during  the  year,  and 
did  not  include  items  which  had  been  earned,  or  become 
due,  but. had  not  been  collected,'  It  was  also  held  under 
that  law  that  items  of  "non-ledger  assets"  shown  in  the 
annual  report  of  a  life  insurance  company,  made  in 
pursuance  to  a  state  statute  as  "uncollected  and  de- 
ferred premiums"  and  "interest  due  and  accrued,"  but 
no  part  of  which  had  been  received,  were  not  a  part  of 
the  company 's  ' '  income  received  during  such  year. ' '  ' 

Bookkeeping  Entries.  Real  facts  and  not  bookkeep- 
ing entries  constitute  income.®  This  does  not  mean 
that  the  return  of  net  income  should  not  be  made  in 
accordance  with  the  taxpayer's  books,  for  ordinarily 
the  books  reflect  the  real  or  actual  facts.  It  means, 
for  instance,  that  if  the  taxpayer  is  reporting  on  the 
basis  of  actual  receipts  and  disbursements,  the  entry 
of  charges  not  yet  collected  will  not  make  him  taxable 
thereon.  In  brief,  the  taxpayer  is  not  precluded,  by  the 
entries  in  his  books  of  account,  from  reporting  his  income 
according  to  actual  facts,  nor  on  the  other  hand  is  the 
Government  precluded  from  going  behind  the  taxpayer's 
books  and  assessing  the  tax  on  the  actual  facts.  In  some 
instances  the  law  places  a  determining  importance  on 

6  Insurance  Company  of  North  America  v.  McCoach,  218 
Fed.  905. 

7  Connecticut  Mutual  Life  Insurance  Co,  v.  Eaton,  218  Fed,  206. 

8  Connecticut  General  Life  Ins.  Co,  v,  Eaton,  218  Fed,  188, 
©Mitchel  Brothers  v,  Doyle,  225  Fed.  437;  U.  S.  v.  N'p^ssinjj 

Mines  Company,  202  Fed.  803;  Baldwin  Locomotive  Works  v. 
McCoach,  215  Fed,  927;  TJ  S,  v.  Guggenheim  Exploration  Com- 
pany, 238  Fed,  231, 


INCOME — IN   GENERAL  209 

bookkeeping  entries,  as  in  -the  case  of  depreciation  and 
losses  of  corporations,  which  must  be  sustained  and 
"charged  off"  in  order  to  be  deducted.  In  the  case  of 
individuals,  losses  need  not  be  "charged  off"  except  in 
the  case  of  worthless  debts.  The  latter  seems  to  be  the 
only  item  of  income  or  deduction  expressly  required  by 
the  law  to  be  evidenced  by  book  entries  in  the  case  of 
individuals.  The  Treasury  Department,  however,  in- 
sists upon  book  entries  of  other  deductions  before  allow- 
ing the  same.  If  the  individual  keeps  books  of  account 
it  is  no  doubt  within  the  power  of  the  Treasury  Depart- 
ment to  require  entries  of  deductions  to  be  made  for 
the  purpose  of  record,  but  a  taxpayer,  not  keeping 
books,  is  not  for  that  reason  precluded  from  claiming 
the  deductions  specified  in  the  law,  except  in  the  case 
of  worthless  debts,  as  noted  above.  No  particular  sys- 
tem of  bookkeeping  or  accounting  is  required  by  the 
department,  but  the  business  transacted  by  the  tax- 
payer should  be  so  recorded  that  each  and  every  item 
set  forth  in  the  return  of  annual  net  income  may  be 
readily  verified  by  an  examination  of  the  books  of  ac- 
count.^** The  books  of  a  corporation  are  assumed  to 
reflect  facts  as  to  its  earnings,  etc.,  hence  they  will  be 
taken  as  the  best  guide  in  determining  the  net  income, 
and,  except  as  the  same  may  be  modified  by  provisions 
of  the  law  wherein  certain  deductions  are  limited,  the 
net  income  disclosed  by  the  books  and  verified  by  the 
annual  balance  sheet,  or  the  annual  report  to  stock- 
holders, should  be  the  same  as  that  returned  for  taxa- 
tion.^* Where  an  individual  or  a  corporation  elects  to 
report  on  the  basis  of  its  books,  and  not  on  the  basis 
of  actual  receipts  and  disbursements,  the  books  must  be 

10  Reg.  33,  Art.  182;  T.  D.  2161. 
n-Reg.  33,  Art.  183. 
F.  I.  Tax.— 14 


210  FEDERAL   INCOME   TAX 

kept  according  to  standard  accounting  systems.  This 
basis  is  more  fully  discussed  in  the  latter  part  of  this 
chapter.  - 

Book  Value  of  Assets.  Neither  the  Government  nor 
the  taxpayer  is  bound  by  valuations  entered  on  the 
books  of  the  taxpayer.^''  Where  property  is  carried  at 
nominal  value  on  the  books  of  the  taxpayer,  and  the 
Government  seeks  to  assess  a  tax  on  the  basis  of  that 
value,  the  taxpayer  may  prove,  by  otlier  evidence,  the 
true  value  of  such  property.*^  A  book  value  increase 
in  the  value  of  capital  assets  due  to  a  re-appraisal  of 
property  is  not  income  within  the  meaning  of  the  law.^* 
A  book  entry  reflecting  only  an  enhanced  value  of  assets 
during  the  year  evidences  an  increase  in  the  net  worth 
of  the  corporation  or  individual  for  that  year,  an  in- 
crease which,  under  adverse  conditions,  may  disappear 
the  next  year.  An  increase  in  value  thus  evidenced  is 
intangible,  unstable  and  is  not  such  income  as  the  law 
contemplates  shall  be  returned  for  the  purpose  of  the 
tax.**  Returnable  and  taxable  income  is  that  actually 
realized  during  the  year,  evidenced  by  the  receipt  of  cash 

12  Doyle  v.  Mitchell,  235  Fed.  686. 

13  U.  S.  V.  Guggenheim  Exploration  Company,  238  Fed,  231. 
In  this  case  the  value  at  which  the  property  was  acquired,  the 
declaration  of  tlio  board  of  directors  as  to  such  value,  at  the  time 
of  acquisition,  and  statements  in  the  annual  reports,  were  held 
to  overcome  in  weight  the  alleged  admission  against  interest  in 
placing  the  valuation  of  the  property  on  the  books  at  a  nominal 
amount, 

14  T.  D.  2005,  Baldwin  Locomotive  Works  v.  McCoach,  221 
Fed.  59, 

IB  Letter  from  Treasury  Department  dated  August  14,  1914; 
L  T.  S.  1917,  11260. 


INCOME — IN   QENEBAL  211 

or  its  equivalent.  Hence  mere  book  entries  of  an  appre- 
ciation in  the  value  of  capital  assets  will  be  disregarded.^* 

.  Inventory.  Taxpayers  engaged  in  manufacturing  or 
mereautile  businesses  usually  determine  their  net  income 
by  inventory,  purchases  during  the  year  plus  the  stock 
on  hand  at  the  beginning  of  the  year,  being  subtracted 
from  sales  during  the  year  plus  stock  on  hand  at  the 
close  of  the  year,  or  vice  versa,  to  ascertain  the  gain  or 
loss.  The  Treasury  Department  recognizes  this  system, 
but  requires  that  in  every  case  where  the  annual  gain  6r 
loss  is  determined  by  inventory,  the  merchandise  must 
be  inventoried  at  cost  price,  as  any  loss  in  salable  value 
will  ultimately  be  reflected  in  the  sales  during  the  year 
when  the  goods  are  disposed  of.  Overhead  charges  are 
not  to  be  included  in  inventory." 

Income  Received  in  Kind.  When  income  is  received 
in  kind,  that  is,  in  produce,  crops,  or  other  property 
having  no  definite  money  value,  the  tax  is  assessible  in 
the  year  in  which  such  income  is  reduced  to  money  or  a 
money  equivalent.^'  If  property  is  exchanged  or  bar- 
tered for  other  property,  neither  having  a  fixed  or  de- 
terminable money  value,  and  the  exchange  is  not  made 
on  the  basis  of  money  value,  no  taxable  income  arises 
from  the  transaction.  Thus,  an  exchange  of  one  horse 
for  another  horse,  does  not  create  taxable  gain  to  either 
party  to  the  transaction  though  each  may  feel  convinced 
he  is  the  richer  by  the  deal.  If  either  party  subsequently 
sells  the  horse  received  by  him  in  the  exchange,  his 
profit  will  then  be  the  difference  between  the  selling 

16  Letter  from  Treasury  Department  dated   August  14,  1914; 
I.  T.  S.  1917,  11249. 
nSee  instructions  on  back  of  Form  10.31. 
II T.  D.  2153. 


212.  FEDERAL   INCOME   TAX 

price  of  that  horse  and  the  cost  to  him  of  the  horse 
he  first  owned.  Rulings  on  this  point  have  not  been  very 
well  defined  by  the  Treasury  Department  up  to  the  pres- 
ent time.  It  has  held,  however,  that  "if  assets  are  ex- 
changed for  other  assets  of  a  like  character,  and  no  ac- 
count is  taken  of  the  compensatory  value,  it  will  be  held 
that  such  a  transaction  constitutes  merely  a  change  in 
the  form  of  assets,  and  the  investment  will  be  considered 
a  continuing  one,  no  profit  or  loss  to  be  taken  into 
account  until  the  assets  are  disposed  of  for  cash  or  its 
equivalent. ' '  ^® 

Income  Received  in  the  Equivalent  of  Cash.    The  law 

expressly  provides  that  stock  dividends  shall  be  taxable 
to  the  same  extent  as  though  the  surplus  they  represent 
had  been  distributed  in  cash.  Salaries,  wages  or  com- 
pensation for  personal  services  of  whatever  kind  "and 
in  whatever  form  paid"  are  taxable  income.  These  are 
the  only  instances  in  which  the  law  expressly  imposes 
a  tax  on  income  received  in  any  form  other  than  cash. 
The  Treasury  Department,  however,  has  ruled  in  a  num- 
ber of  cases  that  income  may  be  taxable  without  neces- 
sarily being  received  in  the  form  of  cash.  Thus,  it 
has  held  in  some  cases  that  payment  made  by  the  issue 
of  stock  of  a  corporation  is  equivalent  to  payment  in 
cash,  but  the  rulings  on  this  point  are  not  yet  very 
well  defined.  The  transactions  with  respect  to  which 
such  rulings  have  been  made  involve  two  points:  (a) 
whether  the  transaction  is  one  in  which  any  income 
can  be  said  to  have  arisen,  and  (b)  whether  the  con- 
sideration received  has  a  sufficiently  fixed  and  definite 
money  value  to  be  considered  the  equivalent  of  cash. 

19  Letter   from    Treasury   Department   dated   August   3,    1917; 
I.  T.  S.  1917,  H  2281. 


INCOME — IN   QENiilKAlj  21^ 

The  diflBcult  questions  arising  in  this  connection  are 
discussed  in  the  following  paragraphs. 

Change  op  Investments.  Where  a  broker  induces 
a  customer  to  change  his  investments,  on  the  basis  of 
market  prices  at  a  certain  time,  the  difference  in  prices 
being  adjusted  by  cash  payment,  such  a  transaction 
seems  clearly  to  be  one  in  which  each  party  is  able  to 
compute  in  money  values  his  gain  or  loss.  Thus,  as 
an  illustration,  Jones  may  have  purchased  a  bond  for 
$900,  and  Smith  may  have  purchased  ten  shares  of 
stock  for  $850.  The  market  for  each  investment  having 
gone  up  ten  points,  Jones  and  Smith  exchange  invest- 
ments, Smith  paying  $50  additional  in  cash.  As  a  result, 
Jones  is  in  possession  of  stock  having  a  market  value 
of  $950  and  $50  in  cash,  while  Smith  has  a  bond  with 
a  market  value  of  $1,000,  but  his  amount  of  cash  is 
reduced  by  $50.  Upon  analysis  it  is  seen  that  the  trans- 
action is  in  fact  a  double  one  equivalent  to  each  party 
having  paid  the  other  in  cash  the  full  market  value  of 
the  security,  and  having  purchased  from  the  other,  for 
cash,  a  new  security.  Each  has  clearly  realized  a  gain 
of  $100  and,  with  respect  to  each,  the  transaction  is  a 
closed  and  completed  one.  It  seems  clear,  therefore, 
that  each  should  report  income  of  $100  in  his  annual 
return.  It  would  also  seem  that  the  same  rule  applies 
upon  the  exchange  of  any  property  having  a  definite 
and  generally  recognized  money  value,  and  the  exchange 
is  made  on  the  basis  of  such  money  value.  Whether  or 
not  it  can  properly  be  applied  to  an  exchange  of  prop- 
erty, where  the  value  is  a  matter  of  speculation,  has  not 
been  determined,  but  it  seems  that  a  transaction  under 
such  conditions  is  not  contemplated  by  the  law  to  be 
capable  of  producing  taxable  income. 


214  li'EDfiR^VL  INCOME  TAX 

Stock  Received  in  Exchange  fok  Services.  Ah 
early  ruling  of  the  Treasury  Department,  under  the 
1913  Law,  held  that  commissions  allowed  salesmen,  paid 
in  stock,  might  be  deducted  as  expense,  if  so  charged 
on  the  books  of  the  corporation,  at  the  actual  value  of 
such  stock.^°  This  is  apparently  on  the  theory  that 
the  transaction  was  equivalent  to  the  salesman  receiv- 
ing payment  for  his  services  in  cash  and  immediately 
investing  the  sum  in  stock.  Conversely,  the  Treasury 
Department  would  no  doubt  hold,  in  order  to  be  con- 
sistent, that  the  value  of  the  stock  would  be  income  to 
the  salesman  as  a  payment  in  the  equivalent  of  cash. 
It  would  seem  to  be  more  sound,  however,  to  argue  that 
the  salesman  received  for  his  services  merely  the  right 
to  share  in  the  future  profits  of  the  company,  and  in 
its  assets  upon  dissolution,  and  received  no  present  tax- 
able consideration,  especially  if  the  stock  had  no  definite 
market  value.  Of  course,  adopting  this  theory,  the  sales- 
man would  be  taxable  upon  the  entire  amount  received 
in  case  any  of  the  stock  should  be  sold,  since  the  stock 
would  be  held  to  have  cost  him  nothing,  while  if  he 
reports  the  value  of  the  stock  as  income  at  the  time  of 
receiving  the  stock,  that  amount  may  be  deducted  from 
the  selling  price  in  computing  the  taxable  profit  on  a 
subsequent  sale  of  the  stock.  In  the  absence  of  more 
definite  rulings  on  this  point,  it  would  seem  that  the 
transaction  could  be  handled  according  to  the  intent 
of  the  parties,  since,  as  a  practical  matter,  if  a  corpora- 
tion deducts  the  value  of  the  stock  so  paid  for  services, 
the  employee  receiving  the  stock  should  report  the  sum 
as  income,  and,  conversely,  if  the  corporation  does  not 
deduct  the  value  of  the  stock  as  an  expense,  the  employee 
should  not  be  required  to  include  it  as  income.     It  is 

20Eeg.  33,  Art.  117. 


INCOME — IS   GENERAL  215 

entirely  a  question  of  who  should  assume  the  burden 
of  the  tax. 

Stock  Received  in  Exchange  for  Property.  If  an 
individual  conducting  business  by  himself  decides  to 
incorporate  and  legally  transfers  his  property  to  a  cor- 
poration in  exchange  for  its  stock  it  does  not  seem  that 
he  should  be  taxed  on  the  theory  that  he  has  received 
payment  in  the  equivalent  of  cash,  since  he  cannot 
possibly  be  any  richer  as  a  result  of  the  transaction, 
and  his  apparent  profit,  if  any,  is  a  mere  "paper  profit," 
not  an  actual  profit.  It  is  argued,  on  the  other  hand, 
that  he  has  gone  through  all  the  legal  forms  of  a  sale 
and  that  the  legal  form  must  govern,  but  it  does  not 
seem,  nevertheless,  that  he  is  in  receipt  of  actual  income 
such  as  the  courts  indicate  the  law  attempts  to  reach. 
The  conclusion  would  not  appear  to  be  different  if  sev- 
eral individuals  pool  their  property  and  form  a  cor- 
poration, since  where  property  is  transferred  to  a  new 
corporation  in  exchange  for  its  stock,  the  transaction  is 
essentially  a  contribution  of  property  to  the  common  fund 
in  anticipation  of  receiving  a  definite  proportion  of  the 
profits  resulting  therefrom.  The  transactions  are  con- 
fusing because  of  the  legal  theory  that  a  corporation  is 
an  entity  separate  and  apart  from  its  shareholders,  and 
such  transactions,  whereby  property  is  contributed  to  a 
corporation,  usually  take  the  form  of  a  sale  between  two 
separate  entities.  The  attitude  of  the  Treasury  Depart- 
ment indicates  that  such  transactions  will  be  considered 
as  sales  between  separate  entities  and  held  to  be  com- 
pleted and  closed  transactions  with  respect  to  the  stock- 
holders. The  second  difficulty  involved  in  such  transac- 
tions is  that  it  is  impossible,  in  many  instances,  to  deter- 
mine with  any  degree  of  certainty  the  money  value  of  the 


216  FEDERAL   INCOME  TAX 

stock  received.  A  custom  has  grown  up  in  this  country 
of  placing  high  valuations  on  property  contributed  to  a 
corporation,  in  order  that  a  greater  par  value  of  stock 
may  be  issued  therefor  without  subjecting  the  stock- 
holder to  liability  for  unpaid  stock.  The  expected  value 
of  the  property  after  a  period  of  development  is  often 
capitalized,  and  future  earnings  are  anticipated.  We 
capitalize  our  corporations  at  a  par  which  we  hope  to 
reach,  instead  of  at  a  par  representing  the  present  value, 
consequently  property  is  often  transferred  to  corpora- 
tions upon  a  valuation  fixed  by  the  directors  in  such 
sums  as  to  create  a  tremendous  "paper  profit*'  to  the 
stockholders  who  contribute  property  in  exchange  for 
the  stock.  As  a  practical  matter,  such  transactions  are 
"not  considered  by  the  parties  thereto  as  "closed  and 
completed"  within  the  sense  that  the  phrase  is  used 
in  the  income  tax  regulations.  The  forms  observed  in 
the  transaction  and  the  seeming  profit  creates  a  prob- 
lem which  the  Treasury  Department  has  proceeded  to 
solve  in  the  cases  that  have  come  before  it  in  such  way 
as  to  create  revenue,  as  is  indicated  in  the  following 
paragraphs. 

Reorganization  op  Corporations.  It  has  been  held 
"that  in  all  cases  wherein  a  corporation  sells  and  trans- 
fers its  assets  to  another  corporation,  the  amount  received 
by  the  selling  corporation  in  excess  of  the  cost  of  the 
property  sold  will  be  considered  income  to  such  selling 
corporation. "  2^    This,  of  course,  is  true  but  the  Treas- 

81  Letter  from  Treasury  Department  dated  September  9,  1916 ; 
I.  T.  S.  1917,  H  1218.  The  original  rulings  of  the  Treasury  Depart- 
ment were  to  the  effect  that  upon  a  reorganization  where  a  new 
corporation  was  formed  with  a  larger  par  value,  the  transfer  of 
the  assets  from  the  old  to  the  new  and  the  exchange  of  stock  by 


INCOME — IN   GKNEBAli  217 

ury  Department  implied  in  this  ruling  that  payment 
in  stock  was  to  be  considered  equivalent  to  payment 
in  cash,  and  stated  that  if  the  shares  of  stock  received 
by  the  selling  corporation  were  distributed  to  its  stock- 
holders, the  amount  so  distributed  in  excess  of  the  stock 
(meaning  apparently  par  value)  held  by  them  in  the 
selling  company  would  be  considered  income  to  the 
stockholders,  to  be  returned  as  dividends.  In  later 
rulings  it  was  held  as  indicated  below. 

Where  Exchange  Is  Par  for  Par.  "Where  in  the 
case  of  reorganization  new  stock  is  acquired  by  a  stock- 
holder in  exchange  for  old  stock  and  both  are  of  the 
same  par  value  no  income  arises  at  the  time  of  exchange, 
but  when  the  new  stock  is  sold  the  gain  must  be  based 
upon  the  cost  of  the  old  stock  or  its  value  on  March  1, 
1913.**  Where  upon  reorganization  of  a  company  stock 
of  the  new  company  is  issued  in  exchange  for  shares 
of  the  old,  the  new  company  taking  over  the  property 

the  stockholders  of  the  old  for  a  greater  par  value  of  stock  of 
the  new,  did  not  create  taxable  income.  Letter  from  Treasury 
Department  dated  May  3,  1915;  I.  T.  8.  1917,  H  1211;  letter  from 
Treasury  Department  dated  April  1,  1915;  I.  T.  S.  1917,  11266; 
in  the  latter  ruling  it  was  said,  ' '  In  this  transaction  there  is  noth- 
ing to  indicate  that  the  two  shares  of  stock  in  the  B  Company 
of  a  par  value  of  $100  each,  had  a  value  in  cash  or  its  equivalent 
in  excess  of  the  value  of  the  stock  in  the  A  Company.  There  is  no 
evidence  other  than  the  difference  in  the  quantitative  par  value 
of  the  shares  of  stock,  that  any  gain,  profit  or  income  was  realized 
from  the  exchange  of  the  shares  of  stock.  It  is  therefore  the 
opinion  of  this  ofSce  that  no  accounting  of  income  will  be  required 
until  such  time  as  the  individual  in  question  seljs  the  stock  of 
the  B  Company  at  a  price  in  excess  of  the  capital  which  be 
originally  invested  in  the  stock  of  the  A  Company." 

W  Letter  from  Treasury  Department  dated  March  8,  1917; 
I.  T.  S.  1917,  12121. 


218  FEDERAL  INCOME  TAX 

of  the  old,  no  income  accrues  if  the  exchange  of  stock 
is  share  for  share  of  like  par  value  even  though  the 
property  of  the  first  corporation  has  increased  in  value 
over  a  period  of  years  since  its  stock  was  first  issued. 
Where  the  stock  of  both  corporations  is  of  like  par 
value  and  predicated  upon  exactly  the  same  assets  the 
transaction  results  in  no  gains,  profits  or  income  to 
either  the  first  corporation  or  its  stockholders.  If  the 
stock  of  the  first  company  at  the  time  of  the  transaction 
was  worth  "double  par"  the  stock  of  the  second  com- 
pany, being  supported  by  identically  the  same  assets, 
is  presumably  of  the  same  value,  and  the  exchange  of 
the  new  stock  for  the  old  results  in  no  income.  It  is 
simply  an  exchange  of  assets  of  like  character  and  like 
value.^'  "Where  an  exchange  is  made  of  stock  of  one 
corporation  for  bonds  in  another  corporation,  the  par 
value  of  the  stock  being  equal  to  the  par  value  of 
the  bonds,  no  taxable  income  is  held  to  result  from  the 
transaction,  the  transaction  being-  an  exchange  of  assets 
of  a  different  form  but  of  equal  value.^* 

Where  the  Exchange  Is  for  a  Greater  Par  Value. 
Where  the  assets  of  one  corporation  are  transferred 
to  another,  the  stockholders  of  the  first  receiving  in 
exchange  for  their  stock  a  greater  amount  of  stock,  par 
value,  in  the  new  corporation,  the  attitude  of  the  Treas- 
ury Department  seems  to  be  that  the  par  value  of  the 
new  stock  is  to  be  considered  as  the  equivalent  of  cash 
and  taxable  to  the  extent  that  it  exceeds  the  cost  of  the 
old.     Where    the   stockholders    of    a    corporation    sur- 

83  Letter  from  Treasury  Department  dated  March  8,  1917 ; 
I.  T.  S.  1917,  112119. 

24  Letter  from  Treasury  Department  dated  August  3,  1917; 
L  T.  S.  1917,  112281. 


INCOME — lU  OENEEAL  219 

rendered  their  stock  for  stock  of  less  par  value,  they  were 
permitted  to  claim  a  loss  on  the  difference  between  the 
cost  of  the  old  and  the  par  of  the  new.** 

Where  the  New  Stock  Has  a  Market  Value. 
Where  a  stockholder  holding  shares  in  a  company 
receives  upon  reorganization  the  same  number  of  shares 
of  the  new  company,  and  an  equal  amount  in  bonds, 
the  bonds  having  a  ready  market  value  of  par,  and  the 
stock  a  value  of  50%  of  par,  it  was  held  that  the  exchange 
constituted  a  closed  and  completed  transaction,  in  that 
the  old  stock  had  been  disposed  of  for  a  readily  deter- 
minable value,  namely,  the  par  value  of  the  bonds  and 
half  the  par  value  of  the  stock,  hence  the  stockholder 
had  realized  on  his  original  investment  a  profit  of  50%, 
which  was  required  to  be  returned  as  income  for  the 
year  in  which  the  transaction  took  place.  In  this  par- 
ticular case  it  was  also  held  that  if  the  stockholder  later 
on  sold  the  bonds  at  par,  and  retained  the  stock,  no 
income  would  be  realized,  and  none  would  be  realized 
until  the  stock  retained  had  been  sold  or  disposed  of 
for  a  price  or  value  greater  than  50%  of  its  par,  which 
amount  was  returnable  as  income  under  the  first 
transaction.*® 

*6  Letter  from  Treasury  Department  dated  March  9,  1917; 
I.  T.  8.  1917,  1  2122. 

W  letter  from  Treasury  Department  dated  August  3,  1917 : 
I.  T.  S.  1917,  H  2281.  It  is  to  be  noted  that  none  of  these  rulings 
on  the  question  of  taxable  income  arising  in  the  exchange  of 
Atock  have  boon  embodied  in  formal  treasury  decisions.  They  are 
all  contained  in  letters  answering  specific  questions,  but  it  is  a 
fact,  nevertheless,  that  the  Treasury  Department  is  proceeding  on 
the  theory  that  taxable  income  does  arise,  and  is  imposing  the 
tax  on  such  transactions.  The  only  reference  to  this  subject 
which  the  author  has  been  able  to  find  in  any  of  the  eases  is  a 


220  FEDERAL   INCOME  TAX 

.  Where  Surplus  op  One  Corporation  Is  Converted 
Into  Capital  op  Another..  Whether  or  not  the  rulings 
indicated  in  the  preceding  paragraphs  on  exchange  of 
stock  will  be  upheld  by  the  courts,  it  seems  that  it  would 
be  sound  to  take  the  position,  in  the  case  of  a  reorganiza- 
tion, that  if  the  old  company  had  surplus  or  undivided 
profits,  which  would  be  taxable  if  distributed  by  it  as 
dividends,  such  surplus  and  undivided  profits  would 
also  be  taxable  if  the  entire  assets  were  turned  over 
to  a  new  corporation  which  treated  the  surplus  and 
undivided  profits  as  being  converted  into  capital  and 
issued  its  stock  to  represent  the  same  in  an  exchange 
with  the  stockholders  of  the  old  corporation.  In  such 
cases  the  surplus  is  converted  into  capital  and  stock 
is  issued  to  represent  such  new  capital,  thus  bringing 
the  transaction  within  the  provisions  of  the  law  relat- 
ing to  stock  dividends.  But  even  so,  the  transaction 
does  not  come  literally  within  the  provisions  of  law 
relating  to  stock  dividends,  as  a  stock  dividend  is  defined 
to  be  a  distribution  of  profits  or  surplus  payable  in 
stock  of  the  corporation  which  earned  the  surplus. 
However,  it  would  seem  that  the  transaction  here 
described  is  tantamount  to  distribution  of  a  stock  divi- 
dend and  should  properly  be  held  to  be  taxable  as  such. 

Payment  in  Notes.  For  income  tax  purposes,  where 
there  is  an  actual  sale  and  transfer  of  real  estate,  profit 
will  be  considered  as  realized  even  though  payment  is 
to  be  made  in  instalments,  as  notes  for  deferred  pay- 
remark  of  the  lower  court  in  the  ease  of  Sargent  Land  Company 
V.  Von  Baumbaeh,  207  Fed.  423,  as  follows:  "The  mere  change 
of  form  of  ownership  from  that  of  these  individuals  to  that  of  a 
corporation  owned  by  the  same  individuals  cannot  produce  sxich 
large  profits  as  are  claimed  here," 


INCOME — IN  GENERAL  221 

raents  are  secured  by  the  title  to  the  property,  and  pre- 
sumably bear  interest,  and  are  held  to  be  worth,  in 
cash,  their  face  value.^  In  determining  the  amount 
of  income  to  be  accounted  for  on  this  basis,  the. seller 
is  required  to  consider  mortgages,  mortgage  notes  or 
any  other  credits  received  in  payment  of  the  property 
as  though  they  were  cash.  If  the  purchaser  should 
later  default  in  payment,  the  seller  will  be  permitted 
to  take  credit,  as  a  loss,  for  the  amount  of  loss  actually 
sustained  by  reason  of  the  default.*'  In  case  of  default 
on  instalment  payments,  there  may  be  charged  off  as 
bad  debts  the  amount  of  such  unpaid  instalments,  less 
the  salvage  value  of  the  real  estate  repossessed.^  A 
promissory  note  in  settlement  of  an  action,  or  in  pay- 
ment of  an  indebtedness  or  of  interest,  is  considered 
to  be  the  equivalent  of  cash  and  so  much  of  such  note 
as  represents  net  income  is  subject  to  tax  as  of  the  year 
in  which  the  note  is  received.^®  This  ruling  seems 
hardly  supported  by  the  decisions  of  the  courts  on  what 
constitutes  income.  A  note  is  a  mere  promise  to  pay, 
and,  at  least  until  the  note  is  discounted,  the  payee  has 
not  in  fact  received  income  any  more  than  he  has  from 
an  unpaid  account  receivable.  To  require  him  to  include 
the  amount  of  notes  received  in  transactions  not  a  part 
of  his  business  or  trade,  is  unjust,  as  in  ease  of  default 
he  would  be  entitled  to  deduct  the  loss  only,  to  a  very 
limited  extent  or,  depending  on  circumstances,  not  at  all. 

Living  Quarters,  Board  or  Lodging.    In  cases  where 
salary,  rent,  or  other  income  is  received  in  some  form 

«7T.  D.  2090. 
MT.  D.  2137. 
W  T.  D.  2090. 

30  Letter   from    Treasury   Department   dated   March    1,    1915; 
T.  T.  S.  1917,1242. 


222  FEDERAL   INCOME   TAX 

other  than  cash,  the  cash  value  of  such  consideration, 
it  is  held,  should  be  computed  and  returned  as  income. 
Thus  where  living  quarters  are  furnished  in  addition 
to  salary,  the  rental  value  of  such  living  quarters  should 
be  reported  as  salary,'^  and  where  board,  lodging,  or 
other  consideration  is  received  in  lieu  of  cash,  the  value 
thereof  should  be  included  as  rent  or  salary,  as  the  case 
may  be.^''  The  law  expressly  provides  that  salaries, 
wages,  or  compensation  for  personal  services  shall  be 
taxable  "in  whatever  form  paid,"  but  does  not  so 
provide  with  respect  to  rent.  These  rulings  would 
be  applicable  to  any  payment  required  by  contract  to 
be  made  in  some  form  other  than  cash,  but  it  does  not 
necessarily  mean  that  because  an  employee  occupies, 
rent  free,  a  house  owned  by  the  employer,  he  must 
return  the  rental  value  as  income.  If  it  was  not  stipu- 
lated in  the  contract  of  employment  that  such  living 
quarters  should  be  furnished  as  a  part  of  the  salary  or 
wages,  the  privilege  of  occupying  the  house  is  in  the 
nature  of  a  gift  and  no  taxable  income  arises.  Similarly 
where  an  employee  uses  his  employer's  property,  horses, 
automobile,  etc.,  by  permission,  and  not  by  legal  right, 
as  a  part  of  his  compensation  for  services,  no  income 
arises  to  him  on  the  ground  that  he  is  receiving  value 
for  which  he  would  otherwise  have  to  pay.  If  a  person 
receives  a  fixed  allowance  to  cover  traveling  or  other 
expenses  and  expends  less  than  the  sum  so  received, 
the  excess  should  be  treated  as  income. 

Receipts  Representing  in  Pait  a  Return  of  Capital. 

In  many  cases  receipts  of  money  represent  in  part  a 
return  of  capital  and  in  part  income  or  profit.     Instal- 

81  T.  i).  2090. 
3«T.  D.  8135. 


INCOME — IN  GENEBAL  223 

rnent  payments  for  goods  sold  is  an   instance.     This 
subject  is  discussed  in  full  in  a  subsequent  chapter.^ 

Income  Taxable  in  Year  Received.  Unless  the  tax- 
payer keeps  his  books  on  a  basis  other  than  that  of 
actual  receipts,  and  reports  accordingly,  he  should  report 
as  income  all  amounts  received  in  the  year  in  which 
payment  is  actually  made.  Thus  dividends  and  inter- 
est, salaries,  professional  fees  of  lawyers,  physicians,  and 
the  like  ^*  need  not  be  returned  as  income  in  the  year 
in  which  they  become  due  or  are  earned,  but  should 
be  returned  as  income  in  the  year  in  which  the  pay- 
ments are  received.  It  is  immaterial  that  the  services 
for  which  payment  may  be  made  have  been  performed 
for  a  period  extending  over  several  years,  the  entire 
payment  is  taxable  in  the  year  in  which  received,  and 
may  not  be  pro-rated.^  In  one  case  it  was  argued  on 
behalf  o^  an  agent  of  a  foreign  insurance  company, 
under  a  contract  by  the  terms  of  which  he  should  receive 
compensation  on  premiums  of  policies  to  the  extent  of 
certain  specified  percentages  for  a  term  aggregating 
twenty  years  from  the  date  of  each  policy,  that  all  of 
the  labor  creating  such  income  had  been  performed  prior 
to  the  incidence  of  the  tax,  but  the  court  held  that 
fact  to  be  immaterial  and  sustained  an  a.ssessment  on 
the  entire  income  for  the  year  in  which  it  was  received.'* 

Accounts  Receivable.     Accounts  receivable  are  con- 
sidered income  for  the  year  in  which  the  account  is 

MSee  Chapter  26. 

84  Letters  from  Treasury  Department  dated  February  18,  1915, 
and  March  1,  1915;  I.  T.  S.  1917;  HI  184,  185  and  228. 
86  T.  D.  2135. 
88  Edwards  v.  Keith,  231  Fed.  110. 


224  FEDERAL  INCOME  TAX 

created,  since  the  Treasury  Department  holds  that  the 
net  income  of  taxpayers  in  manufacturing  or  mercan- 
tile businesses  should  be  ascertained  from  their  books 
and  from  the  actual  inventory  of  merchandise  in  accord- 
ance with  the  established  procedure  in  such  businesses.^"'^ 

Receipt  by  Agent  Is  Receipt  by  Principal. '  A  system 
of  accounting  adopted  by  an  insurance  company,  which 
allowed  a  period  of  two  months  to  local  agencies  in 
which  to  report  their  cash  premium  receipts  to  the 
home  office,  was  held,  in  view  of  the  rules  and  regula- 
tions of  the  Commissioner  of  Internal  Revenue,  not  to 
"clearly  reflect"  the  company's  income.  A  payment 
to  the  agent  was  held  to  be  payment  to  the  principal, 
and  the  company  was  required  to  include  such  pay- 
ments in  the  return  for  the  year  in  which  they  were 
received  by  the  agent.  The  provision  of  the  1916  Law, 
permitting  a  corporation  to  report  according  tQ  its  books, 
was  held  not  to  justify  the  system  followed  by  the 
corporation  in  this  case,  as  the  system  adopted  must  be 
such  as  to  ' '  clearly  reflect  its  income. ' '  ^^ 

Income  from  Foreign  Countries.  Where  income  Ijas 
accrued  in  a  foreign  country  on  foreign  investments 
but  has  not  been  remitted  to  the  owner  here,  being  placed 
to  his  credit  in  the  foreign  country,  he  should  include 
the  same  as  income  for  the  year  in  which  it  is  placed 
to  his  credit,  computing  the  amount  in  United  States 
money  by  using  the  rates  of  exchange  prevailing  at 
the  time  the  amounts  were  credited  abroad.^^ 

87  Letter  from  Treasury  Department  dated  March  31,  1915; 
I.  T.  S.  1917,  11241. 

88  Maryland  Casualty  Company  v.  U.  S.,  Ct.  Cls.,  T.  D.  2451. 
30  Letter  from  Treasury  Department  dated  January  11,  1916; 

L  T.  S.  1917,  If  230.  ' 


INCOME — IN    GENEKAli  225 

Income  Received  from  Porto  Rico  or  the  Philippines. 
A  corporation  or  individual  whose  return  under  the 
law  is  specifically  required  to  be  filed  with  the  collector 
of  one  of  the  districts  of  the  continental  United  States 
would  not  be  taxable  in  Porto  Rico  or  the  Philippines, 
although  a  portion  of  the  income  received  might  be 
derived  from  business  carried  on  in  one  or  both  of  those 
jurisdictions.  Although  the  law  provides  that  income 
collected  in  those  jurisdictions  "shall  accrue  intact  to 
the  general  governments  thereof,"  this  refers  only  to  the 
tax  legally  assessable  therein,  and  does  not  alter  the 
general  rule  that  all  of  the  tax  shall  be  paid  in  the  dis- 
trict in  which  the  taxpayer  resides  or  has  his  or  its  prin- 
cipal place  of  business.*® 

Gross  Income.  The  Treasury  regulations  and  rulings 
refer  to  gross  income  generally  as  the  income  of  the  tax- 
payer before  making  the  deductions  and  allowances  per- 
mitted by  law.  The  statute  does  not  use  the  phrase  gross 
income  but  in  prescribing  the  deductions  allowed  to  cor- 
porations makes  use  of  the  phrase  "gross  amount"  of  its 
income.  Gross  income  is  not  synonymous  with  gross 
receipts. 

Net  Income.  The  phrase  "net  income"  as  used  by  the 
Treasury  Department  seems  to  mean  the  amount  re- 
maining after  subtracting  from  gross  income  the  deduc- 
tions allowed  by  law.  In  the  case  of  individuals  the  net 
income  includes  the  amount  received  as  dividends  and 
the  amount  of  the  pei-sonal  exemption,  that  is,  these 
amounts  are  not  subtracted  from  gross  income  in  arriving 
at  what  is  termed  net  income  but  they  are  subtracted 

*®  Letter  from  Treasury  Department  dated  April  4,  1917. 
P.  I.  Tax.— 16 


226  fediok.Uj  income  tax 

from  net  income  only  in  arriving  at  the  net  taxable 
income  for  the  purpose  of  the  normal  tax. 

Exempt  Income.  The  act  specifically  prescribes  the 
income  which  is  exempt  from  tax.  The  intent  seems  to 
be  that  the  income  shall  be  exempt  (with  four  excep- 
tions) regardless  of  the  status  or  character  of  the  recip- 
ient. The  four  exceptions  are  (a)  proceeds  of  life  insur- 
ance policies;  such  proceeds  are  exempt  only  if  paid  to 
individual  beneficiaries,  not  to  corporations  or  partner- 
ships; (b)  compensation  of  the  President  of  the  United 
States;  (c)  compensation  of  the  Federal  Judges,  and 
(d)  compensation  of  officers  and  employees  of  a  state  or 
political  subdivision  thereof.  In  the  case  of  the  last 
named  class  it  is  held  by  the  Treasury  Department  tbat 
"officers  or  employees"  refer  only  to  individuals.  The 
other  provisions  as  to  exempt  income  have  no  limitation 
with  respect  to  the  character  or  status  of  the  recipient 
and  the  income  would  seem  to  be  exempt  whether  re- 
ceived by  an  individual,  a  partnership  or  a  corporation. 
Such  income'  is  as  follows:  the  amount  received  by  the 
insured  as  a  return  of  premium  or  premiums  paid  by 
him  under  life  insurance,  endowment,  or  annuity  con- 
tracts, either  during  the  term  or  at  the  maturity  of  the 
term  mentioned  in  the  contractor  upon  th*^  surrender  of 
the  contract ;  the  value  of  property  acquired  by  gift,  be- 
quest, devise,  or  descent ;  interest  upon  the  obligations  of 
a  state  or  any  political  subdivision  thereof  or  upon  the 
obligations  of  the  United  States,  (but,  in  case  of  the  obli- 
gations of  the  United  States  issued  after  September  1, 
1917,  only  if  and  to  the  extent  provided  in  the  act  author- 
izing the  issue  thereof)  or  its  possessions  or  securities 
issued  under  the  provisions  of  the  Federal  Farm  Loan 


INCOME — IN   GENERAL  227 

Act  of  July  17,  1916.*^  A  more  complete  discussion  of 
this  class  of  income  is  contained  in  the  several  chapters 
dealing  with  the  respective  kinds  of  income  enumerated. 

Reporting  Income  on  Basis  of  Book  Entries.  The  l&w 
provides  that  an  individual  or  a  corporation  keeping 
accounts  upon  any  basis  other  than  that  of  actual  re- 
ceipts and  disbursements,  unless  such  other  basis  does 
not  clearly  reflect  his  or  its  income,  may  make  returns 
upon  the  basis  upon  which  the  accounts  are  kept,  in 
which  case  the  tax  shall  be  computed  upon  the  income 
as  so  returned.  This  privilege  is  subject,  however,  to 
regulations  made  by  the  Commissioner  of  Internal  Rev- 
enue, which  regulations  may  limit  the  right  as  the  Com- 
missioner sees  fit.**  Taxpayers  who  do  not  keep  books  in 
accordance  with  standard  systems  of  accounting  will 
be  required  to  report  their  net  income  on  the  basis  of 
actual  receipts  and  payments,  but  where  books  are  kept 
in  accordance  with  standard  systems  of  accounting,  or  in 
conformity  with  the  requirements  of '  some  federal, 
state  or  municipal  authority  having  supervision  over  the 
taxpayer,  returns  may  be  made  on  the  basis  on  which 
such  books  are  kept,  provided  the  books  are  so  kept  and 
the  return  so  made  as  to  reflect  the  true  net  income  of 
the  corporation  for  each  year.** 

41  Act  of  September  8,  1916,  §  4,  as  amended  hy  Act  of  Octo- 
ber 3,  1917. 

42  Act  of  September  8,  1916,  8  8  (g)  and  813  (d). 

48  T.  D.  2433.  In  this  ruling  the  Treasury  Department  ha^ 
placed  certain  limitations  upon  the  extent  to  which  reserves  may 
be  set  up  and  deducted.  These  limitations  are  discussed  in  the 
chapters  on  deductions.  While  the  language  of  the  ruling  refers 
particularly  to  corporations,  there  seems  to  be  no  reason  why  it 
should  not  be  applicable  to  individuals  as  well. 


228  FEDERAL   INCOME  TAX 

Same  Basis  Must  Be  Used  Consistently.  Where  a 
taxpayer  adopts  a  system  of  reporting  according  to  his 
books,  he  must  report  consistently  on  this  basis.  He  may 
not  claim  a  right  to  report  on  the  cash  basis  in  part  and 
the  accrual  basis  in  part.  The  two  systems  cannot  over- 
lap.** 

Accrued  Charges.  Under  this  provision,  it  is  per- 
missible for  a  corporation  which  accrues  on  its  books, 
monthly  or  at  other  stated  periods,  amounts  sufficient  to 
meet  fixed  annual  or  other  charges,  to  deduct  the  amount 
so  accrued,  provided  the  accruals  approximate  as  nearly 
as  possible  the  actual  liabilities  for  which  the  accruals 
are  made,  and  income  from  fixed  and  determinable 
sources  accruing  to  the  corporation  is  returned  on  the 
same  basis.*^ 

44  Maryland  Casualty  Company  v.  U.  S.  (Ct.  Cls.)  T.  D.  2451. 
46  T.  D.  2433. 


CHAPTER  17 

INCOME  FROM  PERSONAL  SERVICES 

The  law  expressly  provides  that  the  net  income  of  a 
taxable  person  shall  include  gains,  profits,  and  income 
derived  from  salaries,  wages,  or  compensation  for  pe'r- 
sonal  services  of  whatever  kind  and  w  whatever  form 
paid,  or  from  professions  or  vocations.  It  is  to  be  noted 
that  salaries,  wages,  or  compensation  for  personal  serv- 
ices are  taxable  income  "in  whatever  form  paid."  This 
is  one  of  the  two  cases  in  which  the  law  expressly  specifies 
that  the  tax  shall  be  based  upon  payments  other  than 
in  cash,  the  other  being  the  provision  relating  to  stock 
dividends.  Payment  of  salaries,  wages,  etc.  in  the  form 
of  living  quarters,  board  or  lodging,  is  referred  to  in  the 
preceding  chapter  under  the  head  of  income  received 
in  the  equivalent  of  cash. 

Salaries.  Salaries  should  be  reported  in  the  j'ear  in 
which  they  are  received  and  not  in  the  year  in  which 
earned,  unless  also  received  in  that  year.  Where  a  part 
of  the  compensation  of  an  employee  is  in  the  form  of  a 
salary  payable  monthly,  and  a  part  in  the  form  of  a  bonus 
not  fixed  and  determined  until  on  or  after  January  1,  of 
the  year  following  that  in  which  the  services  were  ren- 
dered, the  fixed  salary  should  be  reported  in  the  year  in 
which  it  is  received  and  the  bonus  should  not  be  reported 
until  return  is  made  for  the  year  in  which  that  is  re- 
ceived.   Thus,  one  receiving  a  bonus  in  January,  1918, 

229 


230  FEDERAL   INCOME  TAX 

for  services  rendered  in  1917,  should  not  report  the 
amount  of  bonus  as  income  until  he  files  his  return  on  or 
before  March  1,  1919.  A  salary  paid  by  a  corporation 
which  is  itself  exempt  from  the  income  tax  is  neverthe- 
less subject  to  tax  in  the  hands  of  the  employee.^  In 
the  case  of  corporations,  so-called  "salaries"  of  stock- 
holders, if  based  on  the  amount  of  stock  held,  are  con- 
sidered to  be  distribution  of  the  net  profits  of  the  corpor- 
ation, not  deductible  as  a  business  expense  of  the  corpor- 
ation, and,  therefore,  not  subject  to  the  normal  tax  in 
tjie  hands  of  the  recipient.'*       , 

Bonuses  and  Profit  Sharing.  AVhere  employees  re- 
ceive bonuses,  or  are  entitled  to  a  share  of  the  profits  of 
the  employer  the  amount  so  received  should  be  included 
as  income,  provided  the  same  is  paid  under  a  contract, 
express  or  implied,  or  a  long  time  practice,  regularly 
employed,  which  constitutes  a  condition,  if  not  a  con- 
tract, under  which  the  employees  may  reasonably  expect 
additional  pay  for  the  greater  or  better  services  which 
they  render.  Such  payments  are  income  to  the  em- 
ployee if  they  are  of  such  character  that  the  employer 
is  entitled  to  deduct  the  same  as  an  expense  of  doing 
business.  If  the  bonus  is  a  mere  gift,  the  employer 
having  the  right  to  pay  or  not  pay  as  it  suits  his 
pleasure,  the  employee  should  not  treat  the  amount  as 
income,  since  gifts  or  gratuities  are  not  taxable,  and 
the  employer  is  not  entitled  to  deduct  the  amount  from 
his  income  as  an  expense  of  doing  business.  The  rules 
governing  the  deduction  of  bonuses  and  profit  sharing 
payments  are  more  fully  treated  under  the  heading  of 

1  T.  D.  2135,  T.  D.  2090. 

2  This  point  is  more  fully  discussed  under  the  head  of  deduc- 
tions in  Chapter  28. 


1NCX)M£  FROM  PERSONAIi  SERVICES  231 

deductions,  which  should  be  read  in  this  connection.' 
The  rule  to  be  followed  by  the  employee  is  that  if  the 
employer  is  entitled  to  deduct  the  amount  as  an  ex- 
pense of  doing  business,  the  employee  should  return 
the  amount  as  income,  and,  vice  versa,  if  the  employer 
is  not  entitled  to  deduct  the  amount  as  expense,  the 
employee  should  not  return  the  amount  as  income,  other- 
wise the  same  sum  of  income  would  be  taxed  twice.  If 
so-called  bonuses  or  profit  sharing  are  paid  to  stock- 
holders of  corporations,  which  are  in  fact  distributions 
of  net  profits  based  on  stock  holding,  they  will  be  con- 
sidered as  dividends  and  held  to  be  taxable  as  such. 

Salaries  of  Partners.  As  a  general  rule  members  of  a 
general  partnership  are  not  entitled  to  salaries,  and  the 
Treasury  Department  will  not  recognize  the  payment 
of  salary  to  a  partner  unless  such  salary  is  provided  for 
in  the  articles  of  partnership  or  by  express  contract. 
The  question  is  not  of  very  great  importance  under  the 
income  tax  law  as  partnerships  are  not  taxed  as  entities, 
but  assumes  importance  under  the  excess  profits  tax  law. 

Voluntary  Offerings  Received  by  Clergymen.  Al- 
though as  a  general  rule  gifts  and  gratuities  are  not 
income,  yet  Easter  offerings,  and  fees  received  by  clergy- 
men for  funerals,  masses,  marriages,  baptisms,  etc.  are 
considered  income,  because  though  in  the  form  of  gifts 
they  are  in  fact  payment  to  the  clergymen  for  services 
rendered.  Christmas  gifts  to  clergymen  do  not  come 
within  this  category,*  The  rule  to  be  observed  is 
whether  or  not  the  money  is  actually  a  gift  or  merely  in 
the  form  of  a  gift. 

«  See  Chapter  28. 
4  T.  D.  2090. 


232  FEDEHAL  INCOME  TAX 

Commissions.  Commissions  paid  to  salesmen  are  in- 
come, which  should  be  accounted  for  in  the  return  of  the 
person  receiving  the  same  in  the  year  in  which  received.^ 

Compensation  for  Services  Extending  Over  a  Year. 

When  money  in  payment  of  services  extending  over  a 
year  is  received  at  the  close  of  the  period  all  of  it  be- 
comes income  for  the  year  in  which  it  is  received.  Thus, 
if  no  determination  has  been  made  of  the  amount  due 
the  trustee  of  an  estate,  as  compensation  for  his  services 
over  a  period  of  years,  until  the  trust  is  terminated,  the 
amount  allowed  him  should  be  returned  in  full  as  in- 
come for  that  year,  and  it  should  not  be  pro-rated  over 
the  length  of  time  the  services  were  rendered.^ 

Compensation  to  Federal  Government  Officers  and 
Employees.  Compensation  received  by  Federal  officers 
and  employees  is  subject  to  tax  whether  paid  in  cash  or 
in  other  forms.  The  entire  sum  received,  however,  is  not 
necessarily  taxable  as  will  be  indicated  in  the  following 
paragraphs.^* 

Living  Quarters.  Commutation  of  quarters  and  the 
money  equivalent  to  quarters  furnished  in  kind  should 
be  returned  as  income.  When  quarters  are  furnished 
in  kind  of  a  less  number  of  rooms  than  the  number 
allowed  by  law,  the  money  equivalent  only  of  the  number 
of  rooms  actually  assigned  should  be  returned  as  income. 
When  quarters  are  furnished  of  a  greater  number  of 
rooms  than  the  number  allowed  by  law,  it  is  to  be  as- 
sumed that  the  excess  number  is  assigned  for  the  conven- 

6  T.  D.  2090. 
6T.  D.  2135. 
6«  See  T.  D.  2079. 


INCOME  FROM  PERSONAL  SERVICES  233 

ience  of  the  Government,  and  the  money  equivalent  only 
of  the  number  of  rooms  allowed  by  law  should  be  re- 
turned as  income. 

He^vt  and  Light.  Amounts  received  by,  or  paid  for, 
an  officer  for  heat  and  light  should  be  returned  as  in- 
come. This  includes  the  money  equivalent,  as  hxed  by 
the  Government,  of  heat  and  light  furnished  to  an  officer 
occupying  public  quarters.  Amounts  expended  for  heat 
and  light  are  in  the  nature  of  personal  living  expenses 
and  differ  in  this  respect  from  amounts  furnished  for 
mileage,  the  latter  being  in  the  nature  of  a  business  ex- 
pense or  an  expense  of  the  employer  rather  than  of  the 
employee. 

Mileage.  Mileage,  as  such,  is  not  income  to  an  officer 
or  employee,  as  he  is  required  to  pay  his  actual  expenses 
while  traveling  under  mileage  orders.  The  difference 
between  the  amount  received  as  mileage  and  the  amount 
of  actual  necessary  expenses  incurred  on  a  journey 
should,  however,  be  returned  as  income.  The  actual 
expenses  to  be  deducted  by  the  individual  before  ascer- 
taining his  income  on  account  of  mileage  are  the  expenses 
for  which  reimbursement  would  be  made  by  the  Govern- 
ment if  he  had  traveled  on  an  actual  expense  basis  in- 
stead of  a  mileage  basis. 

Reimbursement  for  Actual  Expenses,  Amounts 
paid  by  the  Government  in  the  nature  of  reimbursement 
for  subsistence  and  other  items  of  actual  expense  in- 
curred while  absent  on  business  for  the  Government  are 
not  required  to  be  returned  as  income. 

Per  Diem  Allowances.  Per  diera  allowances  in  lieu 
of  subsistence  while  traveling  under  orders  are  not  in- 


234  FEDERAL  INCOME  TAX 

come  except  to  the  extent  that  the  per  diem  allowance 
exceeds  the  amount  of  actual  necessary  expenses  in- 
curred while  so  traveling. 

Compensation  of  Officers  and  Employees  of  a  State  or 
Political  Subdivision  Thereof.  The  compensation  of  all 
officers  and  employees  of  a  state,  or  any  political  subdi-. 
vision  thereof,  is  exemi^t  from  tax,'  except  when  the 
compensation  is  paid  by  the  United  States  Government.* 
This  exemption  applies  to  officers  and  employees  of  the 
state  and  of  its  counties,  municipalities,  townships  and 
other  political  subdivisions.  The  salaries  of  public  school 
teachers  come  within  this  class.®  The  exemption  does 
not  include  an  individual  who  enters  into  a  contract 
with  a  state  for  the  construction  of  public  works,  as  such 
person  is  neither  an  officer  nor  an  employee.^®  It  has 
also  been  ruled  that  where  a  real  estate  corporation  is 
employed  by  a  city  to  appraise  the  value  of  property,  it 
cannot  claim  exemption  as  an  employee.  Officials  of  the 
governments  of  the  District  of  Columbia,  Porto  Rico  and 
the  Philippine  Islands,  or  the  political  subdivisions 
thereof,  do  not  come  within  this  class  and  the  compensa- 
tion paid  to  them  is  not  exempt."  It  seems,  also  that 
the  officers  and  employees  of  a  Territory,  or  any  political* 
subdivision  thereof,  are  not  entitled  to  this  exemption, 
since  the  law  does  not  include  them  and  there  is  not  the 
same  constitutional  objection  to  taxing  them  as  exists 
in  the  case  of  State  employees. 

I  This  exemption  rests  on  the  theory  that  Congress  has  no 
power,  even  by  an  act  taxing  all  incomes,  to  levy  a  tax  on  salaries 
of  state  officers.     See  Collector  v.  Day,  11  Wall.  113. 

8  Act  of  September  8,  1916,  §  4. 

9  Reg.  33,  Art.  5. 

10  T.  D.  2152. 

II  Act  of  September  8,  1916,  §  23. 


I 


INCOME  PROM   PERSONAL  SERVICES  235 

Compensation  of  Federal  Judges.  The  salaries  of 
Judges  of  the  Supreme  Court  and  inferior  courts  of  the 
United  States,  in  office  at  the  time  the  law  was  passed, 
are  exempt  from  the  tax,  but  this  does  not  include  the 
salaries  of  such  judges  as  have  been  appointed  subse- 
quent to  the  passage  of  the  law  or  of  judges  who  have 
been  retired.** 

Compensation  of  the  President  of  the  United  States. 

The  compensation  of  the  President  of  the  United  States 
in  office  at  the  time  the  law  was  passed  is  exempt  from 
the  tax  during  the  term  for  which  he  was  elected.*^      , 

Professions  and  Vocations.  Incomes  from  professions 
and  vocations  are  taxable  as  is  income  from  any  other 
source.  No  rulings  are  specially  applicable  to  these 
forms  of  income.  Such  income  is  taxable  in  the  year  in 
which  it  is  received,  not  necessarily  for  the  year  in  which 
it  is  earned.  Rulings  as  to  this  point  are  general  and  are 
discussed  in  the  preceding  chapter. 

18  Act  of  September  8,  1916,  §4;  T.  D.  2090.  This  exemption 
was  inserted  in  view  of  the  provision  of  the  Federal  Constitution, 
Art.  3,  §  1,  which  guarantees  that  the  compensation  of  Federal 
judges  shall  not  be  diminished  during  their  continuance  in  office. 
See  Opinion  of  Justice  Field  in  Pollock  v.  Farmers  Loan  &  Trust 
Company,  157  U.  S.  429;  and  13  Op.  Atty.  Gen.  161. 

18  Act  of  September  8,  1916,  §  4.  In  an  opinion  of  the  Attorney 
Greneral  in  1869  it  was  held  that  a  specific  tax  by  the  United 
States  upon  the  salary  of  the  President  in  oflBce  at  the  t'me  the 
act  was  passed,  to  be  deducted  from  the  salary  which  otherwise 
would  be  paid  him,  would  be  a  diminution  of  his  compensation  in 
contravention  of  Article  2,  Section  1,  Clause  7,  of  the  Federal  Con- 
stitution, which  provides  that  the  compensation  of  the  Prcsid'Jnt 
shall  neither  be  increased  or  diminished  during  the  period  for 
which  he  shall  have  been  elected.  13  Op.  Atty.  Gen.  162.  This 
consideration  no  doubt  moved  Congress  to  grant  the  exemption  in 
the  present  law. 


CHAPTER  18 

INCOME  FROM  BUSINESS,  TRADE  OR  COMMERCE 

Income  from  this  source  is,  as  indicated  in  the  title, 
the  income  derived  by  an  individual  or  a  corporation 
from  business,  trade  or  commerce  in  which  he  or  it  is 
engaged.  With  respect  to  this  class  of  income  the  phrase 
gross  income  has  a  meaning  which  differs  from  that  of 
gross  receipts  as  indicated  in  the  following  paragraphs. 

Gross  Income  in  Manufacturing  Businesses.  The  gross 
income  of  a  manufacturing  business  consists  of  total  sales 
of  manufactured  goods  during  the  year  covered  by  the 
return,  increased  or  decreased  by  the  gain  or  loss  as 
shown  by  the  inventories  of  finished  or  unfinished  prod- 
uts,  raw  material,  etc.,  at  the  beginning  and  end  of  the 
year.^  A  manufacturer  may  include  as  an  element  of 
the  cost  of  manufactured  products,  the  cost  of  the  raw 
material,  the  cost  of  labor  of  the  men  who  actually  work 
on  such  products,  as  well  as  the  cost  of  supervisory,  or-;^-^ 
what  may  be  denominated  as  "unproductive"  labor, 
such  as  that  of  the  foreman,  inspectors,  overseers,  etc., 
provided  such  expenditures  are  not  separately  deducted 
from  gross  income  in  the  return  of  annual  net  income.* 

Gross  Income  in  Mercantile  Businesses.  The  gross 
income  of  a  mercantile  business  should  include  the  total 

1  Peg.  33,  Art.  104. 
«  T.  D.  2152. 

236 


INCOME  FKOM  BUSINESS,  TRADE  OR  COMMERCE       287 

merchandise  sales  during  the  year,  increased  or  de- 
creased by  the  gain  or  loss  as  shown  by  the  inventories  of 
merchandise  at  the  beginning  and  end  of  the  year  for 
which  the  return  is  made.* 

Inventory.  Where,  in  order  to  arrive  at  the  correct 
amount  of  income,  it  is  necessary  that  an  inventory,  or 
its  equivalent,  of  materials,  supplies,  and  merchandise 
on  hand  for  use  or  sale  at  the  close  of  each  year  shall  be 
made  in  order  to  determine  the  gross  income  or  to  de- 
termine the  expense  of  operation,  a  physical  inventory 
is  at  all  times  preferred  by  the  Treasury  Department. 
Where  a  physical  inventory  is  impossible  and  an  equiva- 
lent inventory  is  equally  accurate,  the  latter  will  be 
accepted.  An  equivalent  inventory  is  an  inventory  of 
materials,  supplies,  and  merchandise  on  hand  taken  from 
the  books  of  the  taxpayer.*  The  Treasury  Department 
requires  inventories  to  be  taken  at  the  cost  price.' 

Gross  Income  of  Insurance  Companies.  Special  rules 
are  applicable  to  ascertaining  the  gross  income  of  insur- 
ance companies.  These  rules  are  discussed  in  the  chap- 
ter on  insurance  companies.® 

Gross  Income  Generally.  The  gross  income  of  the 
taxpayer  is,  generally  speaking,  his  total  income  derived 
from  the  operation  and  management  of  his  or  its  busi- 

«Reg.  33,  Art.  105. 

♦  Reg.  33,  Art.  161. 

B  Although  the  Department  is  positive  in  its  stand  on  this  point, 
it  seems  to  have  issued  no  express  ruling  or  regulation,  the  only 
express  reference  to  the  requirement  that  inventory  be  taken  at 
cost  being  in  the  instructions  on  the  back  of  the  form  of  return 
of  net  income  of  corporations.    8«e  Form  1031. 

•  See  Chapter  13. 


238  FEDERAL   INCOME   TAX 

ness  and  property,  together  with  all  amounts  of  in- 
come  from  all  other  sources.  It  embraces,  of  course, 
not  only  the  income  of  a  manufacturer  or  dealer  from 
his  business,  but  also  income  from  all  other  sources  such 
as  rentals,  royalties,  interest,  dividends,  and  profits 
from  the  sale  of  assets.'' 

Income  of  Contracting'  Companies.  Where  a  con- 
tracting company  has  contracts  which  may  run  for  a 
period  of  several  years,  it  may  prepare  its  return  in 
such  manner  that  its  gross  income  will  be  arrived  at 
on  the  basis  of  completed  work;  that  is  to  say,  on  jobs 
which  have  been  finally  completed  and  payments  made 
during  the  year.  If  the  gross  income  is  arrived  at  by  this 
method,  the  deductions  from  gross  income  should  be 
limited  to  the  expenditures  made  on  account  of  such 
completed  contracts.* 

Income  from  Export  Business.  Income  from  the 
business  of  exporting  goods  is  held  to  be  taxable  by 
the  Treasury  Department.  It  has  also  been  held  that 
a  tax  on  such  income  is  not  a  tax  on  the  articles  ex- 
ported, and  therefore  not  unconstitutional  in  that 
regard.® 

Accounts  Receivable.  Accounts  and  bills  receivable 
of  a  business  concern  are  treated  by  the  Treasury 
Department  as  income  for  the  year  in  which  they  are 
created;    that   is,   in   the  year   in  which   the   accounts 

7Eeg.  33,  Arts.  106  and  107. 

«T.  D.  2161. 

9  Peck  V.  Lowe,  234  Fed.  125.  It  was  so  held  by  the  District 
Court  in  which  the  case  w^as  first  decided.  At  the  present  time 
the  case  is  before  the  Supreme  Court  on  appeal. 


1NCX>M£  FROM  BUSINESS,  TRADE  OR  COMMERCE       239 

are  set  up   on  the  books  or   the  bills   receivable  are 
accepted.*" 

Goods  Sold  on  Approval.  Where  goods  are  sold  on 
approval,  the  purchaser  paying  the  full  price  at  the 
time  of  sale,  but  having  the  privilege  of  returning 
the  goods  within  a  certain  period,  the  amount  received 
upon"  the  sale  should  be  included  as  income.  Subse- 
quently if  the  goods  are  returned  and  the  purchase 
price  refunded  the  refund  may  be  deducted  as  a  loss 
or  the  sum  may  be  treated  as  a  **  purchase  during  the 
year"  by  the  seller.  This  procedure  would  seem  to 
l)e  proper  in  any  case  where  the  transaction  is  in  the 
course  of  the  taxpayer's  business  or  trade.  Where, 
however,  an  individual  sells  property  in  a  transaction 
not  connected  with  his  business  or  trade,  with  the  privi- 
lege on  the  part  of  the  buyer  of  returning  the  property 
within  a  certain  period  and  receiving  back  the  pur- 
chase price,  the  transaction  should  not  be  considered 
as  closed  and  completed  until  the  period  during  which 
the  property  may  be  returned  has  expired.  Otherwise 
if  the  taxpayer  includes  the  profit  on  such  transaction 
in  his  income  for  the  year  he  may  not  be  able  to  avail 
himself  of  the  loss  of  that  profit  if  the  refund  takes 
place  in  a  subsequent  year,  since  the  loss  can  be  offset 
only  against  gains  in  similar  transactions  during  the 
latter  year.  The  proper  method  of  handling  such  trans- 
actions would  seem  to  be  to  hold  the  payment  "in  sus- 
pense" until  the  title  has  passed  without  condition  from 
the  seller  to  the  buyer,  and  to  enter  the  profit  on  the 
transaction  as  income  for  the  year  in  which  that  takes 
1)1  ace. 

!•  Letter  from  Trea.sury  Department  dated  March  2,  191.5; 
T.  T.  a.  1917,  111183. 


240  FEDERAL   INCOME  TAX 

Pajrments  by  Instalment.  If  payments  for  goods 
sold  are  made  in  instalments  by  the  buyer,  a  propor- 
tionate part  of  each  instalment  represents  the  profit  on 
the  sale  of  the  goods  and  the  rest  represents  a  return  of 
capital  to  the  seller.  The  manner  of  treating  the  income 
arising  on  the  payment  on  such  instalments  is  described 
in  a  later  chapter.^^ 

Income  from  Business  of  Certain  Public  Utilities  May 
Be  Exempt.  The  larw  expressly  exempts  from  tax  any 
income  derived  from  any  public  utility  or  from  the 
exercise  of  any  essential  governmental  function  accruing 
to  any  state,  territory  or  the  District  of  Columbia  or 
any  political  subdivision  of  a  state  or  territory.  It 
further  provides  that  whenever  any  state,  territory  or 
the  District  of  Columbia  or  any  political  subdivision 
of  a  state  or  territory  has,  prior  to  the  passage  of  the 
law,  entered  in  good  faith  into  a  contract  with  any 
person  or  corporation,  the  object  and  purpose  of  which 
is  to  acquire,  construct,  operate  or  maintain  a  public 
utility,  no  tax  shall  be  levied  upon  the  income  derived 
from  the  operation  of  such  public  utility  so  far  as  the 
payment  thereof  will  impose  a  loss  or  burden  upon  such 
state,  territory,  district  or  political  subdivision,  but  this 
does  not  confer  upon  any  person  or  corporation  any 
financial  gain  or  exemption  or  relieve  any  such  person 
or  corporation  from  the  payment  of  a  tax  as  provided 
for  in  the  law  upon  that  part  or  portion  of  such  income 
to  which  such  person  or  corporation  is  entitled  under 
the  contract.^^ 

11  See  Chapter  26. 

12  Act  of  Septemher  8,  1916.  811  (h). 


INCOME  PROM  BUSINESS,  TRADE  OB  COMMERCE       241 

Income  from  Partnerships.  The  net  income  of  a 
partnership  from  business,  trade  and  commerce  and 
from  all  other  sources  is  returned  by  the  partners 
under  the  foregoing  general  rules  and  the  special  rules 
discussed  in  the  chapter  on  partnerships.** 

13  See  Chapter  1(X. 


F.  I.  Tax.— 16 


CHAPTER  19 

INCOME   FROM    FARMING 

Special  rules  have  been  made  with  respect  to  farms 
and  farmers.^  In  connection  therewith  the  term  "farm" 
is  defined  as  embracing  the  farm  in  the  ordinary  accepted 
sense,  plantations,  ranges,  stock  farms,  poultry  farms, 
dairy  farms,  fruit  farms,  truck  farms,  and  all  lands 
used  for  similar  purposes;  and  the  term  "farmers"  is 
defined  as  all  persons  who  cultivate  and  operate  or  man- 
age farms  for  gain  or  profit,  either  as  owners  or  tenants. 

"Gentlemen  Fanners."  A  person  cultivating  or  oper- 
ating a  farm  for  recreation  or  pleasure,  on  a  basis  other 
than  the  recognized  principles  of  commercial  farming, 
the  result  of  which  is  a  continual  lo^  from  year  to  year, 
is  not  regarded  as  a  farmer.  In  such  cases,  if  the  opera- 
tion of  a  farm  results  in  a  net  gain  for  the  year,  such 
gain  must  be  included.  If,  however,  the  expenses  and 
losses  incurred  in  connection  with  the  farm  are  in  excess 
of  the  receipts  the  entire  receipts  from  the  sale  of 
products  may  be  omitted  from  the  return  of  income; 
and  the  expenses,  being  regarded  as  personal  expenses, 
will  not  be  allowed  as  a  deduction  from  income  derived 
from  other  sources. 

Fanners  Keeping  Books.  Farmers  who  keep  books, 
according    to    some    approved    method    of    accounting, 

1  T.  D.  21.53. 

242 


INCOME  FROM    KAKMINO  248 

which  clearly  show  the  net  income,  are  permitted  to 
prepare  their  returns  from  such  books  although  the 
method  of  accounting  may  not  strictly  be  in  accordance 
with  the  rules  which  are  laid  down  for  farmers  who  do 
not  keep  books. 

Income  from  Sale  of  Farm  Products.  All  gains, 
profits  and  income  derived  from  the  sale  or  exchange 
of  farm  products,  whether  produced  on  a  farm  or  pur- 
chased and  resold  by  the  farmer,  must  be  reported 
as  income  for  the  year  in  which  the  products  were 
actually  marketed  and  sold,  or  exchanged  for  money 
or  a  money  equivalent. 

Income  from  Rents  Received  in  Kind.  Kents  re- 
ceived in  crop  shares  are  to  be  reported  as  income 
in  the  year  in  which  the  crop  shares  are  reduced  to 
money  or  a  money  equivalent. 

Deductions.  Farmers  may  deduct  all  legitimate  ex- 
penses incident  to  the  production  of  the  y^ar,  or  future 
years,  although  the  products  to  which  such  expenses  and 
deductions  are  incidental  may  not  have  been  sold.  Where 
farm  products  are  held  for  favorable  market  prices, 
no  deduction  on  account  of  shrinkage  in  weight  or 
physical  value,  or  losses  by  rea.son  of  .such  shrinkage  or 
deterioration  in  storage,  are  allowed.  The  cost  of  stock 
purchased  for  resale  may  at  the  option  of  the  farmer  be 
deducted  as  an  expense  or  taken  into  consideration  upon 
the  sale  of  such  stock.  Money  expended  for  stock  for 
breeding  purposes  may  not  be  deducted  as  an  expense, 
but  is  regarded  as  capital  invested.  "Where  stock,  which 
has  been  purchased  for  any  purpose,  dies  from  disease 
or  injury,  or  is  killed  bv  order  of  state  or  federal  authori- 


244  FEDERAL   INCOME   TAX 

ties,  and  the  cost  thereof  has  not  been  claimed  as  an 
item  of  expense,  the  actual  purchase  price  of  such  stock, 
less  any  depreciation  which  may  have  been  claimed,  may 
be  deducted  as  a  loss.  Property  destroyed  by  order  of 
state  or  federal  authorities  may*  be  claimed  as  a  loss. 
If  reimbursement  is  made  by  the  state  or  federal  authori- 
ties, in  whole  or  in  part,  on  account  of  the  destruction 
of  stock  or  property,  the  amount  so  received  is  to  be 
reported  as  income.  The  cost  of  ordinary  tools  may 
be  deducted  as  an  expense,  but  not  the  cost  of  farm 
machinery.  Depreciation  may  be  claimed  on  farm  ma- 
chinery and  on  farm  buildings  (except  the  dwelling 
occupied  by  the  owner)  and  other  physical  property, 
including  stock  purchased  for  breeding  purposes.  No 
claim  for  depreciation  will  be  allowed  on  stock  raised 
or  purchased  for  resale,  as  the  cost  thereof  may  either 
be  deducted  as  an  expense  oi*  taken  into  account  at  the 
time  the  stock  is  sold.  These  deductions  are  discussed 
in  detail  in  the  several  chapters  on  deductions.^ 

8  See  Chapters  20  to  32,  inclusive. 


CHAPTER  20 

INCOME  PROM  SALES  OR  DEALINGS  IN  PROPERTY 

The  law  expressly  provides  that  gains,  profits  and 
income  derived  from  sales  or  dealings  in  property, 
whether  real  or  personal,  growing  out  of  the  owner- 
ship or  use  of  or  interest  in  real  or  personal  property, 
shall  be  taxable.*  It  has  been  argued  that  gains  result- 
ing from  an  increase  in  capital  should  not  be  taxed, 
in  cases  where  an  owner  was  not  engaged  in  the  busi- 
ness of  dealing  in  such  property,  but  the  language 
of  the  law  is  broad  enough  to  cover  all  transactions 
whether  or  not  the  taxpayer  is  a  dealer.  The  case  of 
Gray  v.  Darlington  *  construing  the  income  tax  act  of 
1864  held  that  the  gain  to  an  individual  resulting 
from  the  sale  of  property,  purchased  by  him  several 
years  before,  was  not  taxable,  on  the  theory  that  the 
increased  value  of  the  property  could  not  be  said  to 
be  gain  in  any  particular  year  of  the  time  during 
which  it  was  held.  It  has  been  argued  that  the  rule 
laid  down  in  this  case  should  be  applied  to  the  present 
law,  but  a  comparison  of  the  statute  under  which  the 
case  was  decided  with  the  1913  and  1916  Laws  leads 
to  the  conclusion,  on  the  part  of  the  author,  that  the 
case  has  no  application  to  the  language  of  the  later 

1  Act  of  September  8,  1916,  8  2  (a). 
«15  Wall.  63;  21  L.  Ed.  45. 

245 


246  FEDERAL  INCOME  TAX 

statutes.3  The  intent  of  the  1913  Law  and  the  1916 
Law  seems  clearly  to  be  that  gains  from  sales  or  deal- 
ings in  property,  regardless  of  whether  the  property 
is  sold  in  the  course  of  a  business  or  trade  or  other- 
wise, shall  be  taxed.  It  has  been  held  by  the  Treasury 
Department  that  gains  and  profits  resulting  from  a 
sale  of  property  are  subject  to  tax.*  The  gain,  profit 
or  income  is  the  amount  by  which  the  selling  price 
exceeds  the  cost.  Book  values  are  ignored  where  they 
do  not  represent  the  actual  cost  of  the  properties.  The 
entire  profit  is  taxable  unless  the  property  was  acquired 
prior  to  the  incidence  of  the  tax.^ 

Cost  of  Property.  The  cost  of  property  is  the  actual 
price  paid  for  it  at  the  time  of  purchase,  together  with 
the  expense  of  procuring  it  and  the  expense  of  selling 
it.  If  improvements  or  betterments  have  been  made 
the  cost  of  such  improvements  or  betterments  may  also 
be  added  to  the  cost  of  the  property.®  It  is  also  per- 
missible to  add  to  the  initial  cost  of  the  property  such 
carrying  charges  as  interest,  taxes,  insurance,  etc.,  pro- 
vided such  carrying  charges  have  not  been  deducted 

3  Under  the  1909  Law,  it  was  held  that  the  profit  from  the 
sale  of  stock  purchased  in  1902  and  sold  in  1911  was  not  income 
to  any  extent  whatever,  the  court  following  the  case  of  Gray  v. 
Darlington.  Gauley  Mountain  Coal  Company  v.  Hays,  230  Fed. 
110.  The  Darlington  case  was  also  followed  in  Industrial  Trust 
Company  v.  Walsh,  222  Fed.  437,  in  holding  that  an  increase  in 
the  book  value  of  property  did  not  constitute  income  under  the 
1909  Law.  Other  cases  held  the  profit  taxable.  The  case  of  Gray 
V.  Darlington  is  more  fully  discussed  in  Chapter  43  on  the  consti- 
tutionality of  the  present  law. 

4T.  D.  2090;   T.  D.  2137. 

6  T.  D.  2090 ;  letter  from  Treasury  Department  dated  August 
14,  1914;  L  T.  S.  1917,  11262. 

6  T.  D.  2090. 


INCOME  FROM  SALES  OR  DEALINGS  IN  PROPERTY      247 

from  net  income  in  any  annual  return  of  the  owner 
subsequent  to  the  income  tax.'' 

Profit  Not  Based  on  Book  Values.  The  value  at 
which  property  is  carried  on  the  books  of  the  owner 
is  not  conclusive  evidence  of  its  actual  value.  Where 
the  Government  attempts  to  impose  a  tax  upon  the 
difference  between  the  book  value  and  selling  price, 
the  taxpayer  may  show  by  other  evidence  the  actual 
cost  thereof  or  the  actual  value  at  the  incidence  of 
the  tax.* 

Sh.vres  of  Same  Stock  Bought  at  Different  Prices. 
When  various  parcels  of  stock  of  the  same  issue  are 
bought  and  sold  on  different  dates  and  at  different 
prices,  the  shares  sold  should  be  identified,  if  possible, 
by  the  numbers  of  the  certificates  covering  them,  and 
the  cost  of  the  identical  shares  should  be  deducted  in 
order  to  determine  the  profit.  Where  it  is  impossible 
to  identify  the  shares  in  this  manner,  the  shares  should 
be  considered  to  be  sold  in  the  order  in  which  they 
were  purchased,  that  is,  the  cost  of  the  first  shares 
purchased  should  be  deducted  from  the  selling  price 
of  the  first  shares  sold.® 

Property  Acquired  by  a  Corporation  for  Stock. 
In  cases  where  property  was  taken  over  by. a  corpora- 
tion in  exchange  for  its  capital  stock,  at  a  par  value 
greatly  in  excess  of  the  true  value  of  the  property,  and 
such  property  is  later  sold,  it  has  been  held  by  the 
Treasur>'  Department  that  it  will  be  necessary  to  ascer- 

7T.  D.  2137. 

8U.  S.  V.  Guggenheim  Exploration  Company,  238  Fed.  231. 
9  Letter  from  Treasurj-  Department   «lated  February  26,  1916; 
I .  T.  8.  1917,  H  280. 


248  FEDERAL   INCOME   TAX 

tain  as  nearly  as  possible  the  true  value  of  the  property 
at  the  time  it  was  taken  over,  and  any  excess  over 
this  ascertained  value  is  income.  Similarly,  it  has  been 
ruled  that  where  corporations  have  acquired  for  a  mere 
nominal  sum,  property  which  at  the  time  of  its  acquire- 
ment had  a  value  greatly  in  excess  of  such  sum,  a 
careful  estimate  of  the  value  of  the  property  at  the 
time  it  was  acquired  may  be  fixed  and  set  up  as 
the  value  representing  the  cost  of  the  property,  and 
any  excess  over  such  fixed  value,  at  which  such  prop- 
erty may  thereafter  be  disposed  of,  will  be  treated  as 
income.  The  value  of  property  so  fixed  is  subject  to 
the  approval  of  the  Internal  Revenue  Bureau.^® 

Rule  as  to  Farmers.  The  cost  of  stock  purchased 
for  resale  may  be  deducted  by  a  farmer  under  the  item 
of  expense  in  the  year  in  which  the  stock  is  purchased.^* 
This,  however,  is  not  an  absolut^  requirement,  since 
a  farmer  may  purchase  stock  to  such  an  extent  that 
the  cost  would  more  than  offset  his  income  for  the 
year.  He  may  therefore  treat  the  amount  paid  for 
stock  in  the  same  manner  as  the  cost  of  any  other 
property,  that  is,  make  no  deduction  at  the  time  of 
purchase,  but  deduct  such  cost  from  the  selling  price 
at  the  time  of  sale  and  report  only  the  remainder  as 
profit.  Money  expended  for  stock  for  breeding  pur- 
poses is  regarded  as  capital  invested  and  such  sums 
may  not  be  deducted  as  expense  in  the  year  in  which 
the  stock  is  purchased.  The  amount  so  paid  for  stock 
for  breeding  purposes  may  be  taken  into  consideration 
under  the  head  of  depreciation,  that  is,  the  total  sum 
paid  may  be  divided  by  the  number  of  years  in  which 

10  T.  D.  2161. 

11  T.  D.  2153. 


INCOME  PROM  SALES  OR  DEALINGS  IN  PROPERTY      249 

the  stock  is  expected  to  live,  or  be  useful  for  the  pur- 
poses for  which  bought,  and  the  resulting  sum  may 
be  deducted  from  each  year's  income.  Should  such 
stock  be  sold  at  any  time,  the  cost  thereof,  less  the 
aggregate  amount  which  has  been  so  claimed  as  depre- 
ciation, may  be  deducted  from  the  selling  price,  the 
remainder,  if  any,  constituting  income. 

Property  Left  by  a  Decedent.  When  an  individual 
dies  after  March  1,  1913,  leaving  property,  all  gains 
or  losses  on  subsequent  sales  should  be  computed  on 
the  basis  of  the  appraised  value  of  the  property  at  the 
date  of  death  of  the  former  owner.  Neither  the 
executors  nor  anyone  acquiring  the  property  of  the 
decedent  is  required  to  make  a  return  of  the  book  gains 
or  losses  up  to  the  date  of  death.  If  the  executors  should 
sell  the  property  the  difference  between  the  appraised 
value  at  the  date  of  death  and  the  selling  price  consti- 
tutes the  taxable  profit.  If  the  property  is  transferred 
to  a  beneficiary  of  the  estate  no  income  accrues  to  the 
beneficiary  as  a  result  thereof,  since  the  value  of  prop- 
erty acquired  by  gift,  bequeSt,  devise  or  descent  is 
exempt  from  tax.  Any  income  which  the  beneficiary 
thereafter  derives  from  such  property  is  taxable  and, 
if  such  property  is  sold,  the  difference  between  the 
appraised  value  of  the  property  at  the  date  of  decedent's 
death  and  the  selling  price  constitutes  the  taxable 
profit.^*  In  cases  where  an  individual  died  prior  to 
March  1,  1913,  the  value  on  March  1,  1913,  of  any 
property  left  by  the  decedent  is  the  amount  to  be  used 
as  a  basis  for  computing  the  taxable  profit  in  any  sub- 
sequent sale  by  the  executors  or  the  beneficiaries. 

18  Telegram  from  Treasury  Department  dated  February  3,  1917; 
T.  T.  S.  1917,  1 1999. 


250  FEDERAL   INCOME  TiSX 

Property  Acquired  Before  March  1,  1913.  The  1916 
Law  provides  that  for  the  purpose  of  ascertaining  the 
gain  derived  or  loss  sustained  from  the  sale  or  other 
disposition  of  property,  real,  personal,  or  mixed,  acquired 
before  March  1,  1913,  the  fair  market  price  or  value 
of  such  property  as  of  March  1,  1913,  shall  be  the 
basis  for  determining  the  amount  of  such  gain  derived 
or  loss  sustained.*'  This  provision  applies  in  all  cases 
of  individuals  and  corporations.  In  all  such  cases  the 
original  cost  of  the  property  is  disregarded  and  the  value 
as  of  March  1,  1913,  is  taken,  whether  or  not  such  value 
is  more  or  less  than  the  original  cost.**  Under  the  1909 
and  1913  Laws  it  was  the  practise  of  the  Department 
to  require  the  taxable  profit  to  be  determined  by  first 
ascertaining  the  difference  between  the  cost  and  the 
selling  price  and  then  pro-rating  the  result  according 
to  the  number  of  months  the  property  was  held  before 
and  after  the  incidence  of  the  tax,  but  this  rule  has 
no  application  under  the  present  laws. 

Market  Value  of  Securities  on  March  1,  1913. 
Where  stock,  acquired  prior  to  INIarch  1,  1913,  is  sold, 
and  such  stock  was  traded  in  on  an  exchange,  the  fair 

13  Act  of  September  8,  1916,  §  2  (c),  §  5  (a),  §  6  (a),  §  10. 

14  This  provision  first  appeared  in  the  1916  Law,  no  reference 
being  made  in  the  1909  Law  or  the  1913  Law  as  to  assets  acquired 
prior  to  the  incidence  of  the  tax.  In  one  case  under  the  1909  Law 
it  was  held  that  profit  on  the  sale  of  property  purchased  prior  to 
January  1,  1909,  and  sold  thereafter  was  income  only  to  the 
extent  that  the  selling  price  exceeded  the  ascertained  market 
value  on  January  1,  1909.  (Cleveland,  etc..  Railway  Company  v. 
U.  S.,  242,  Fed.  18.)  In  ajiother  case  it  was  held  that  where  the 
assets  were  acquired  for  the  purpose  of  sale,  the  inventory  value 
at  the  time  of  the  incidence  of  the  tax  should  be  the  basis. 
(Doyle  V.  Mitchell,  235  Fed.  686;  149  C.  C.  A  106.) 


INCOME  FROM  &VLES  OB  DEALINGS  IN  PROPERTY      251 

market  price  or  value  as  of  March  1  is  held  to  be  the 
average  price  for  the  day  in  cases  where  there  is  a 
variation  between  the  opening  and  closing  price." 

Special  Rule  in  Case  op  Book  Values  Reported 
Under  1909  Law.  Under  the  provisions  of  the  1909 
Law  the  Treasury  Department  permitted  income  to  be 
computed  on  the  basis  of  changes  in  book  values.  Hence, 
where  a  corporation  for  the  years  1909  to  1912  inclusive, 
made  its  returns  strictly  in  accord  with  the  regulations 
then  in  force,  the  increase  of  book  values  of  property 
being  returned  as  income  and  corresponding  decreases 
being  deducted,  as  the  regulations  then  required  and 
permitted,  the  profit  on  such  property  could  be  com- 
puted under  the  1913  Law  by  deducting  the  amount 
of  the  last  adjusted  value  subsequent  to  January  1,  1909, 
without  pro-rating  as  required  in  other  cases. ^*  This 
ruling  has  no  application  under  the  1916  Law,  which 
expressly  requires,  in  all  cases,  that  the  gain  be  based 
on  the  value  as  of  March  1,  1913,  regardless  of  any 
book  values  prior  thereto. 

Selling  Price.  The  selling  price  is  the  amoiuit  re- 
ceived for  the  property.  It  may  be  held  to  be  taxable 
whether  received  in  cash  or  in  the  equivalent  of  cash. 
For  a  discussion  of  income  received  in  the  equivalent 
of  ea.sh,  see  chapter  on  income  in  general." 

16  Letter  from  Treasury  Department,  dated  November  21,  1916; 
T.  T.  S.  1917,  11273. 
16  T.  D.  2130. 
"See  Chapter  16. 


CHAPTER  21 

INCOME  PROM  RENT 

Rent  is  returnable  as  income  in  the  year  in  which 
it  is  received,  and  not  necessarily  in  the  year  in  which  it 
becomes  due.  Thus,  where  a  tenant  pays  part  of  his 
rent  for  the  preceding  year  on  the  second  day  of  Janu- 
ary of  the  following  year,  the  amount  so  paid  is  income 
to  the  landlord  for  the  year  in  which  it  is  received, 
and  not  the  year  which  it  covers.^  This  rule,  how- 
ever, is  not  absolute,  as  the  landlord  may,  if  he  keeps 
his  books  accordingly,  report  the  rent  for  the  year  in 
which  the  income  accrues  and  charge  against  it  the 
deductions  for  the  same  period. 

Value  of  Improvements  Made  by  Tenant.  Where, 
under  the  terms  of  a  rental  or  lease  contract,  a  tenant 
agrees  to  erect  a  building  or  to  expend  during  the 
rental  period  a  certain  fixed  sum  in  making  improve- 
ments upon  the  freehold  oL  the  lessor,  it  is  held  for 
income  tax  purposes  that  the  building  or  permanent 
improvement  becomes  a  pSrt  of  the  realty  unless  other- 
wise agreed  between  the  contracting  parties;  and,  as 
such,  must  be  accounted  for  as  gain  or  profit  to  the 
lessor  at  the  time  the  lease  is  terminated,  whether 
terminated  by   expiration   or  otherwise.     The   amount 

1  Letter  from  Treasury  Department  dated  February  9,  1915; 
I.  T.  S.  1917,  H  226. 

3.53 


i 


INCOME  FROM   BENT  253 

of  the  gain  or  profit  to  the  lessor  at  the  termination  of 
the  lease  is  the  difference  between  the  cost  of  the 
building  or  improvement  so  made  by  the  tenant  and  a 
reasonable  allowance  for  depreciation  during  the  period 
of  its  life  under  the  lease." 

Lessor  Corporations.  Where  a  corporation  leases  all 
of  its  property  to  another  and  specifies  that  the  consid- 
eration therefor  shall  be  paid  direct  to  its  stockholders 
and  bondholders  or  creditors  the  lessor  corporation  is, 
nevertheless,  held  to  be  the  proper  recipient  of  the  in- 
come and  must  report,  as  rent,  the  amount  so  paid  to  its 
stockholders,  bondholders  or  creditors  by  the  lessee.' 

Payments  by  Tenant  on  Behalf  of  Landlord.  Where 
under  the  terms  of  a  lease  a  tenant  pays  taxes  or  interest, 
or  makes  any  other  payments  for  and  on  behalf  of  the 
landlord,  the  amount  of  such  payments  constitutes  income 
to  the  landlord  and  should  be  reported  by  him  as  such. 
The  theory  covering  these  transactions  is  that  the  tenant 
is  acting  merely  as  agent  for  the  landlord  in  making 
such  payments.  The  expenses  are  the  landlord's,  which 
he  may  deduct  from  his  net  income,  and  the  amounts 
used  to  defray  such  expenses  must  be  included  by  the 
landlord  as  his  ne^  income.  Such  payments  may  be 
deducted  by  the  tenant  as  rent  in  the  year  in  which 
they  are  paid. 

2  T.  D.  2442.     It  necessarily  follows  that  the  teuaut  may  con 
aider  tlie  cost  of  the  building  as  a  part  of  his  rental  payments  and 
may  deduct  such  amount  as  an  expense,  pro-rating  the  original 
cost  over  the  number  of  years  constituting  the  term  of  the  lease. 
See  Chapter  28. 

*  For  a  further  discussion  of  this  subject  see  sub-heading 
entitled  lessor  and  Lessee  Corporations  in  Chapter  12. 


254  FEDERAL   INCOME  TAX 

Receipt  of  Rent  in  Kind.  Where  rent  is  received  in 
the  form,  of  produce,  as  for  instance,  a  share  of  the  crops 
of  a  farm,  the  amount  realized  on  the  sale  of  such  share 
must  be  included  as  income  in  the  year  in  which  the 
share  is  disposed  of  or  reduced  to  money  or  its  equiva- 
lent. Where  board  or  lodging  is  given  as  the  equivalent 
of  rent,  the  value  of  such  board  or  lodging  is  required  to 
be  included.* 

4  See  Chapter  16  for  statement  on  receipt  of  income  in  kind  or 
in  the  equivalent  of  cash. 


CHAPTER  22 

INCOME  PROM   INTEREST 

Income  derived  in  the  form  of  interest  is  taxable  in 
the  hands  of  citizens  and  residents  and  domestic  cor- 
porations, whether  received  from  debtors  in  this  coun- 
try or  debtors  in  foreign  countries.  Interest  is  taxable 
in  the  hands  of  non-resident  aliens  and  foreign  corpora- 
tions when  derived  from  interest  bearing-obligations  of 
residents,  corporate  or  otherwise.^ 

Interest  Exempt  from  Tax.  The  Act  expressly  pro- 
vides that  interest  upon  the  obligations  of  a  state,  or 
any  political  subdivision  thereof,  or  upon  the  obligations 
of  the  United  States  (with  certain  exceptions  noted  be- 
low), or  its  possessions,  or  securities  issued  under  the 
provisions  of  the  Federal  Farm  Loan  Act  of  July  17, 
1916,  shall  be  exempt. 

Interest  on  Obligations  op  the  United  States.  The 
interest  received  on  obligations  of  the  United  States  is 
exempt  in  the  case  of  all  obligations  issued  on  or  before 
September  1,  1917.  In  the  case  of  obligations  issued 
after  that  date  the  interest  is  exempt  only  if  and  to  the 
extent  provided  in  the  Act  authorizing  the  issue  thereof.* 

1  Act  of  September  8,  1916,  81  (a). 

8  Under  earlier  income  tax  laws  interest  upon  the  obligations 
of  the  United  States  was  expicssly  included  as  taxable  income. 
(See  Act  of  March  2,  1867).    Under  the  1909  Law  the  Attorney 

255 


256  PEDEBiVL   fNCOME   TAX 

Second  Liberty  Loan  Bonds.  The  Act  authorizing 
the  issue  of  the  Second  Liberty  Loan  Bonds  provides^ 
that  the  bonds  and  certificates  issued  thereunder  "shall 
be  exempt,  both  as  to  principal  and  interest,  from  all 
taxation  now  or  hereafter  imposed  by  the  United  States, 
or  any  State,  or  any  of  the  possessions  of  the  United 
States,  or  by  any  local  taxing  authority,  except  (a) 
state  or  inheritance  taxes,  and  (b)  graduated  additional 
income  taxes,  commonly  known  as  surtaxes,  and  excess 
profits  and  war-profits  taxes,  now  or  hereafter  imposed 
by  the  United  States,  upon  the  income  or  profits  of  in- 
dividuals, partnerships,  associations,  or  corporations. 
The  interest  on  an  amount  of  such  bonds  and  certificates, 
the  principal  of  which  does  not  exceed  in  the  aggregate 
$5,000,  owned  by  any  individual,  partnership,  associa- 
tion, or  corporation,  shall  be  exempt  from  the  taxes  pro- 
vided for  in  Subdivision  (b)  of  this  section."  It  will 
be  noted  that  bonds  of  this  issue  are  not  subject  to  the 
normal  tax  nor  to  the  income  tax  of  6%  if  held  by  cor- 
porations. Where  a  husband  and  wife  each  own  in 
his  or  her  own  right  bonds  of  this  issue  not  exceeding 
$5,000,  each  is  entitled  to  exclude  the  income  therefrom 
in  computing  the  tax  on  their  joint  incomes.  Minor  chil- 
dren having  separate  estates  are  also  each  entitled  to 
the  same  exemption.*  A  taxpayer  holding  bonds  and 
certificates  of  indebtedness  issued  under  this  Act  is  en- 
General  held  that  interest  on  National  Bonds  should  be  included 
as  income  of  corporations,  since  the  tax  was  not  a  tax  on  property, 
but  a  tax  on  the  privilege  of  carrying  on  business.  (28  Op.  Atty. 
Gen.  138). 

8  Act  of  September  24,  1917  (Public  No.  43),  §  7. 

4  Letter  from  Treasury  Department  dated  October  8,  1917;  I. 
T.  S.  1917,  H  2439. 


INCOME   PROM    INTEREST  257 

titled  to  the  exemption  oii  $5,000  of  his  aggregate  hold- 
ings, not  on  $5,000  of  each  class  of  obligations.** 

Obligations  of  the  Possessions  op  the  United 
States.  Interest  paid  on  the  obligations  of  possessions 
of  the  United  States  is  exempt.  Interest  on  the  obliga- 
tions of  the  territories,  or  political  subdivisions  thereof, 
can  be  considered  as  exempt  only  \)n  the  ground  that 
the  territories  are  possessions  of  the  United  States,  since 
the  law  does  not  expressly  include  territories  in  the 
exemption  provision. 

Interest  on  the  Obligations  op  a  State.  Th^  same 
principle  which  denies  to  a  state  power  to  raise  revenue 
ti,\  taxation  on  federal  property,  or  sources  of  revenue, 
or  means  of  carrying  on  its  duties,  forbids  taxation  of 
state  revenue  for  federal  purposes.*  Therefore  the 
I'nited  States  has  no  power  under  the  Constitution  to 
tax  either  the  instrumentalities  or  the  property  of  a 
state.*  A  municipal  corporation  is  a  portion  of  a 
sovereign  power  of  a  state  and  is  not  subject  to  taxation 
by  Congress  upon  its  municipal  revenue."'  But  the  ex- 
emption of  state  agencies  does  not  extend  to  those  used 
li.\  the  state  in  carrying  on  an  ordinary  private  business.* 
Interest  on  the  obligations  of  a  state  is,  therefore,  ex- 
pressly exempt.  The  1909  Law,  however,  being  an  excise 
tax  and  not  an  income  tax,  was  valid  although  measured 
by  income  which  included  interest  from  state  securities.* 

♦*T.D.  2585. 

'Collector  v.  Day,  11  Wall.  113;  Ambrosini  v.  U.  8.  187  U.  S.  1. 
«  Pollock  V.  Trust  Company,  157  U.  8.  429,  584. 
1  V.  S.  .',  Railroad  Company,  17  Wall.  322. 
»  South  Carolina  v.  U.  S.  199,  U.  8.  437. 
»  Flint  V.  Stone  Tracy  Co.,  220  U.  8.  107. 
P.  I.  Tax.— 17 


258  FEDERAL   INCOME  TAX 

Political  Subdivision  of  a  State,  Difficulty  is  some- 
times encountered  in  determining  whether  bonds  issued 
by  districts  or  divisions  of  a  state  are  exempt  under  this 
phrase.  The  Attorney  General  has  held  that  special 
assessment  districts  created  for  a  public  purpose,  such 
as  the  improvement  of  streets  and  public  highways,  the 
provision  of  sewage,  gas  and  light  and  the  reclamation, 
drainage,  or  irrigation  Of  land  are  districts  for  public 
use,  and  consequently  political  subdivisions  of  the  state, 
within  the  meaning  of  the  law.^**  Levee  and  school  dis- 
tricts lawfully  created  and  authorized  by  the  state  to 
levy  a  tax  to  meet  the  obligations  of  such  district  are 
also  held  to  be  political  subdivisions  of  the  state.  In 
general  the  term  "political  subdivision"  includes  special 
assessment  districts  or  divisions  created  by  proper 
authority  of  the  state  acting  within  its  constitutional 
powers  and  under  its  general  laws,  for  the  purpose  of 
carrying  out  a  portion  of  those  functions  of  the  state 
which  by  long  usuage  and  inherent  necessities  of  govern- 
ment have  always  been  regarded  as  public.^^ 

Mortage  Assumed  by  Municipality.  Although  in- 
terest on  municipal  bonds  are  exempt  from  the  tax,  yet 
where  a  municipality  has  purchased  k  public  utility  sub- 

10  Opinion  of  Attorney  General  dated  January  30,  1914.  In 
the  course  of  his  opinion  the  Attorney  General  said:  "  *  *  » 
where  the  power  to  levy  a  tax  is  given  a  district  by  the  state, 
presumptively  that  district  is  created  for  a  public  use,  and  is 
exercising  a  public  function.  *  *  *  Nor  does  it  make  any 
difference  that  the  tax  is  measured  by  the  benefit  conferred. ' '  But 
he  refrained  from  expressing  any  opinion  whether  assessment  dis- 
tricts might  not  be  created  for  a  purely  private  purpose  so  as  to 
bring  them  within  the  principles  laid  down  in  the  South  Carolina 
Dispensary  case,  199  U.  S.  437,  rather  than  within  those  which 
governed  U.  S.  v.  Railroad  Company,  17  Wall.  322. 

11  T.  D.  1946. 


INCOME  FROM   INTEREST  259 

ject  to  a  mortgage,  and  the  mortgage  retains  its  original 
character,  even  though  the  municipality  assumes  the 
mortgage  indebtedness  and  pays  the  interest  thereon, 
the  mortgage  does  not  become  an  obligation  of  the  munici- 
pality within  the  meaning  of  the  law  and  the  interest 
thereon  is  not  exempt.*" 

Interest  on  Bonds  of  Exempt  Orgajiizations.  Al- 
though a  corporation  may  under  Sec.  11  of  the  1916  Law 
be  exempt  from  a  tax  on  its  income,  yet  interest  on  the 
bonds  of  such  an  organization  is  taxable  income  to  the 
bondholder.*' 

Accrued  Interest  on  Obligations  at  Time  of  Purchase. 
Where  a  purchaser  pays  the  price  of  the  security  pur- 
chased and  an  additional  sura  representing  accrued  in- 
terest, the  amount  of  interest  received  on  the  next  in- 
terest date  should  not  be  reported  in  full.  The  amount 
of  accrued  interest  at  the  time  of  purchase  represents 
the  return  of  capital  to  the  purchaser  and  he  should 
deduct  such  amount  from  the  interest  received,  and  re- 
port the  remainder  only.  The  seller  of  the  security 
should  account  in  his  return  for  the  accrued  interest 
ii'ceived  at  the  time  of  sale,  since  to  him  that  amount  is 


income 


14 


12  T.  D.  2090. 

13  Letter  from  Treasury  Department  dated  July  30,  1914;  I. 
T.  S.  1917,  If  1222. 

14  Letter  from  Treasury  Department  dated  February  5,  1915; 
I  T.  S.  1917,  t  232.  In  a  later  ruling  the  Treasury  Department 
declined  to  permit  the  taxpayer  in  such  a  case  to  report  all  of  the 
interest  received  as  income  and  to  deduct  the  amount  of  accrued 
interest  paid  at  the  time  of  purchase  as  an  expense  or  as  interest 
paid  by  the  purchaser.  Letter  dated  March  8,  1915,  I.  T.  8.  1917, 
1237. 


260  FEDERAL    INCOME   TAX 

Interest  on  Bank  Deposits.  Interest  on  bank  deposits 
or  on  certificates  of  deposit,  credited  to  the  account  of 
the  depositor  by  the  bank,  is  income  for  the  year  in  which 
the  credit  is  made.^* 

Interest  Received  and  Paid  by  Brokers.  Where  the 
customers  of  a  brokerage  house  buy  securities,  paying 
only  a  part  of  the  purchase  price  and  paying  interest 
on  the  balance,  and  the  brokerage  house  buys  such  se- 
curities from  others,  paying  only  a  part  of  the  purchase 
price  and  paying  interest  on  the  balance,  the  brokerage 
house  must  include  in  its  return  as  gross  income  the  in- 
terest received  from  the  customers  and  may  deduct  as 
interest  the  amount  of  interest  it  pays  on  such  purchases 
limited,  in  the  case  of  corporations,  to  the  amount  of  in- 
terest which  may  be  deducted  under  the  law.^® 

Interest  Accruing  Prior  to  March  1,  1913.  Where 
interest  became  due  prior  to  March  1,  1913,  and  funds 
have  been  on  hand  to  pay  the  same  since  the  due  date 
the  amount  is  not  taxable,  since  it  represents  income 
that  was  due  and  payable  and  could  have  been  reduced 
to  possession  on  demand  prior  to  the  incidence  of  the 
income  tax.  Even  where  interest  has  been  in  default 
since  a  time  prior  to  March  1,  1913,  and  funds  to  pay 
the  same  have  accrued  since  that  date,  it  has  been  held 
that  the  interest  represents  income  accrued  to  the  owners 
of  the  bonds  prior  to  the  incidence  of  the  tax,  and  hence 

16  Reg.  33,  Art.  67 ;  Letter  from  Treasury  Department  dated 
February  18,  1915;  I.  T.  S.  1917,  1[240. 

16  Altheimer  and  Eawlings  Investment  Co.  v.  Allen,  T.  D.  2441. 
This  case  was  decided  under  the  1909  Law  but  the  principle  seems 
to  apply  to  the  language  of  the  present  law.  Interest  would  be 
deducted  in  full  if  paid  on  collateral  the  subject  of  sale  in  the 
ordinary  course  of  business. 


INCOME   FROM    INTEREST  261 

does  not  constitute  taxable  income  when  received  there- 
after." 

17  Letter  from  C!ollector  at  Cincinnati  dated  March  16,  1915, 
embodying  decision  of  the  Treasury  Department;  I.  T,  S.  1917, 
H  332. 


CHAPTER  23 

INCOME  FROM   DIVIDENDS 

The  law  expressly  states  that  the  net  income  of  a 
taxpayer  shall  include  gains,  profits  and  income  derived 
from  dividends.^ 

Definition.  The  term  ''dividends"  as  used  in  the  law 
is  defined  therein  to  mean  any  distribution  made  or 
ordered  to  be  made  by  a  corporation,  joint  stock  com- 
pany, association,  or  insurance  company,  out  of  its  earn- 
ings or  profits  accrued  since  March  1st,  1913,  and  pay- 
able to  its  shareholders,  whether  in  cash  or  in  stock  of 
the  corporation.^  It  is  to  be  noted  that  under  this  defini- 
tion any  distribution  which  is  made  or  ordered  to  be 
made  by  a  corporation  is  a  dividend.  It  need  not  neces- 
sarily be  called  a  dividend  or  be  made  in  the  ordinary 
course  of  business.  A  distribution  of  assets  at  the  time 
of  liquidation  of  a  corporation  would  be  a  dividend 
to  the  extent  that  the  assets  so  distributed  included  earn- 
ings or  profits  accrued  since  March  1st,  1913.  On  the 
other  hand,  if  the  distribution  is  not  out  of  its  earn- 
ings or  profits  accrued  since  March  1st,  1913,  it  does 
not  become  a  dividend  within  the  meaning  of  the  law 
by  reason  of  the  fact  that  it  is  called  a  dividend  by  the 
corporation  making  the  distribution. 

1  Act  of  September  8,  1916,  §  2  (a). 

2  Act  of  September  8,  1916,  as  amended  by  Act  of  October  3, 
1917,  §  31. 

262 


i 


INCOME  FROM   DIVIDENDS  263 

Dividends  on  Life  Insurance  Policies.  It  is  a  cus- 
tom of  insurance  companies  to  return  each  year  a  portion 
of  the  premium  paid  by  the  insured.  The  amount  so 
returned  is  usually  designated  as  a  "dividend"  and  is 
either  received  in  cash  by  the  insured  or  applied  by 
him  to  the  reduction  of  the  next  annual  premium.  Such 
"dividends"  are  not  considered  taxable  income  under 
the  law  and  should  not  be  included  in  th'e  annual  return. 
Where,  however,  dividends  are  received  on  a  paid-up 
policy  the  amount  must  be  included  and  should  be  con- 
sidered the  same  as  dividends  from  corporations,'  unless, 
of  course,  the  dividend  was  not  paid  by  the  insurance 
company  out  of  earnings  or  profits  accrued  since  the 
incidence  of  the  tax. 

Dividends  from  Associations.  Since  limited  part- 
nerships, associations,  joint  stock  companies  and  insur- 
ance companies  (whether  incorporated  or  not)  are 
treated  as  corporations,  the  net  earnings  of  such  organ- 
izations should  be  considered  as  dividends.*  Thus  pri- 
vate banks,  which  have  the  form  of  corporate  organiza- 
tion, are  required  to  make  returns  as  corporations,  and 
the  owners  of  the  bank  are  authorized  to  treat  as  divi- 
dends the  earnings  which  they  receive  therefrom.*  The 
recipient  of  profits  of  associations  or  limited  partner- 
.ships  should,  therefore,  ascertain  whether  the  association 
or  partnership  is  reporting  its  income  as  an  entity, 
and  in  such  event  should  treat  the  net  profits  of  the 
association  as  dividends. 

8T.  D.  2137. 

♦  T.  D.  2152.     See  Chapter  12  for  definition  of  the  term  "cor- 
porations. ' ' 
»T.  D.  2137. 


264  FEDERAL   INCOME   TAX 

Extent  to  Which  Dividends  Are  Taxable.  The  extent 
to  which  a  dividend  is  taxable  depends  upon  the  status 
of  the  corporation  paying  the  same,  and  upon  the  status 
of  the  recipient  of  the  dividend.** 

Dividends  op  Domestic  Corporations.  In  the  case 
of  dividends  declared  and  paid  by  a  domestic  corpora- 
tion, which  is  taxable  upon  its  net  income  under  the 
law,  the  dividend  is  not  subject  to  the  normal  tax  if 
received  by  an  individual.  If  the  individual  is  a  non- 
resident alien,  exemption  from  the  normal  tax  on  such 
dividends  will  be  allowed  only  in  case  he  files  a  return 
of  his  total  net  income,  received  from  all  sources  in  the 
United  States,  in  the  manner  prescribed  by  law.  If 
such  dividend  is  received  by  a  corporation,  domestic 
or  foreign,  it  is  subject  to  the  2%  tax  imposed  by  the 
1916  Law,  but  is  not  subject  to  the  4%  tax  imposed  by 
the  1917  Law. 

Dividends  op  Non-Resident  Foreign  Corporations. 
Dividends  of  ^  non-resident  foreign  corporation,  if  paid 
out  of  its  earnings  or  profits  accrued  since  March  1st, 
1913,  are  taxable  when  received  by  a  citizen  or  resident 
of  this  country,  and  must  be  reported  for  the  purpose 
of  both  the  normal  tax  and  the  supertaxes.  When 
received  by  a  domestic  corporation  such  dividends  are 
taxed  under  the  1916  Law  and  the  1917  Law.  Such 
dividends  received  by  non-resident  aliens  or  foreign 
corporations  are  subject  to  no  tax,  although  the  divi- 
dend may  be  paid  by  the  paying  agent  for  such  cor- 
poration at  a  place  within  the  United  States. 

Dividends  Paid  by  Resident  Foreign  Corporations. 
When  a  foreign  corporation  derives  its  entire  income 

6a  The  rate  depends  upon  the  ye&r  in  which  the  ]irofits  were 
accumulated  by  the  corporation.     See  p.  267. 


INCOME  FROM  DIVIDEVrDS  265 

from  business  done  wholly  within  the  United  States,  and 
pays  the  income  tax  upon  its  entire  net  income,  divi- 
dends declared  by  it  should  be  treated  in  the  same  man- 
ner as  dividends  from  domestic  corporations.®  It  seems, 
also,  that  if  a  foreign  corporation  pays  the  income  tax 
on  a  part  of  its  net  income,  the  dividends  it  pays  should 
be  treated,  to  that  extent,  as  dividends  of  domestic  cor- 
porations are  treated.  Thus,  if  a  foreign  corporation 
pays  the  income  tax  on  half  of  its  income,  half  of  its 
dividends  should  be  free  from  normal  tax  when  paid 
to  individuals,  and  from  the  1917  tax  when  paid  to 
corporations. 

Dividends  Received  by  Citizens  and  Residents, 
When  dividends  are  received  by  individuals  who  are 
citizens  or  residents  of  this  country,  they  must  be  in- 
cluded in  the  return  of  annual  net  income;  but  for  the 
purpose  of  assessing  the  normal  tax  under  each  of 
the  present  laws,  the  amount  of  dividends  received  from 
the  net  earnings  of  any  corporation  taxable  upon  its 
net  income,  as  indicated  in  the  foregoing  paragraphs, 
may  be  excluded.  For  the  purpose  of  assessing  the 
supertaxes  under  each  of  the  present  laws,  such  divi- 
dends must  be  included.  The  same  rule  applies  where 
dividends  are  received  by  the  estate  of  a  deceased  citi- 
zen or  resident  or  by  a  trust  estate  created  by  a  citizen 
or  resident.  The  fact  that  an  individual  may  not  have 
legal  title  to  the  stock  on  which  the  dividends  are  de- 
clared does  not  alter  the  rule,  if  he  is  the  actual  bene- 
ficial owner.  Therefore,  the  amount  which  may  be 
received  by  a  trustee  in  the  form  of  dividends  may 
be  treated  as  dividends  by  the  beneficiary  in  makinjr 
his  return :  and  similarly  dividends  received  by  a  part 

ST.  D.  2090. 


266  FEDERAL   INCOME  TAX 

nership  are  treated  as  dividends  received  by  the  partners, 
when  the  partners  make  their  personal  returns  of  their 
net  distributive  shares  in  the  profits  of  the  partnership. 

Dividends  Received  by  Non-Resident  Aliens.  A 
non-resident  alien  is  subject  to  the  normal  tax  on  divi- 
dends of  domestic  corporations,  unless  he  files  or  causes 
to  be  filed  a  return  of  annual  net  income  showing  his 
total  income  received  from  all  sources,  corporate  or 
otherwise,  in  the  United  States,  in  the  manner  prescribed 
for  non-resident  aliens.  By  so  doing  he  is  entitled  to 
claim  exemption  from  the  normal  tax  on  the  amount 
of  dividends  received  from  any  corporation  taxable  upon 
its  net  income.''  Although  this  exemption  from  normal 
tax  may  be  enjoyed  by  a  non-resident  alien  only  by 
filing  a  return  of  annual  net  income,  the  normal  tax 
is,  nevertheless,  not  deducted  at  the  source  upon  pay- 
ments of  dividends  to  non-resident  aliens,  since  the  sec- 
tion of  the  law  providing  for  deduction  at  the  source 
expressly  declares  that  it  shall  not  apply  to  income 
derived  from  dividends  on  capital  stock,  or  from  the 
net  earnings  of  a  corporation  which  is  taxable  upon  its 
net  income.®  Dividends  received  by  a  non-resident,  alien 
from  the  net  earnings  of  foreign  corporations  are  not 
income  from  sources  within  this  country,  even  though 
the  dividend  is  paid  in  this  country. 

Dividends  Received  by  Corporations.  With  respect 
to  the  2%  tax  imposed  by  the  1916  Law,  a  corpora- 
tion must  include  in  its  taxable  income  all  dividends 

7  Act  of  September  8,  1916,  §6  (c),  as  amended  by  Act  of 
October  3,  1917. 

8  Act  of  September  8,  1916,  §9  (b),  as  amended  by  Act  of 
October  3,  1917. 


INCOME  PROM    DIVIDENDS  267 

received  from  corporations  of  which  it  may  be  a  stock- 
holder, whether  the  paying  corporation  is  taxable  on 
its  net  income  or  not.  For  the  purpose  of  computing 
the  4%  tax  imposed  by  the  1917  Law,  a  corporation 
may  exclude  the  amount  it  receives  as  dividends  upon 
the  stock  of  any  other  corporation,  which  is  taxable  upon 
its  net  income.® 

Dividends  Received  by  Nominal  Stockholders. 
When  a  dividend  is  received  by  one  who  is  not  the 
actual  owner  of  the  stock,  but  is  the  owner  of  record, 
he  is  not  required  to  include  the  amount  in  his  own 
income  tax  return,*®  but  should  proceed  in  accordance 
with  the  rules  stated  in  the  chapter  on  nominal  stock- 
holders.** 

Dividends  on  Stock  op  Federal  Reserve  Banks. 
Dividends  or  income  derived  from  the  stock  of  Federal 
Reserve  Banks  is  exempt  fron*  the  tax  on  the  theory 
that  the  exemption  provided  for  in  the  Federal  Reserve 
Act  attaches  to  and  follows  the  dividends  into  the  hands 
of  the  member  banks  holding  the  Federal  Reserve  Bank 
stock.** 

Dividends  from  Profits  or  Surplus  of  Prior  Years. 
The  rate  of  tax  on  dividends  received  in  1917  or  sub- 
sequent years,  depends  upon  the  year  in  which  the 
amount  distributed  as  dividends  was  earned  by  the 
paying  corporation.     The  law  provides  expressly  that 

9  Act  of  October  3,  1917,  Title  I.  8  4. 

10  Letter  from  Treasury  Department  dated  November  21,  1916; 
I.  T.  S.  1917,  f  183. 

11  See  Chapter  7  on  Nominal  Stockholders. 
1«  Federal  Reserve  Bulletin,  April  1,  1916. 


268  FEDERvVL   INCOME   TAX 

the  dividends  shall  be  a  part  of  the  annual  income 
of  the  distributee  for  the  year  in  which  received,  but 
shall  be  taxed  to  the  distributee  at  the  rates  prescribed 
by  law  for  the  years  in  which  such  profits  or  surplus 
were  accumulated  by  the  corporation. ^^  The  language 
of  this  provision  is  obscure,  but  it  seems  to  mean,  for 
instance,  that  if  an  individual  receives  a  dividend  from 
profits  or  surplus  accumulated  by  the  corporation  in 
1916,  he  will  add  it  to  the  amount  of  his  income  reported 
for  1916  and  pay  the  supertax  thereon  at  the  1916  rates; 
and  similarly  with  respect  to  dividends  from  profits  or 
surplus  accumulated  in  1915,  1914,  or  1913.  When  such 
dividends  are  received  by  a  corporation,  the  computation 
is  more  simple,  as  there  is  no  graduated  tax  to  be  taken 
into  consideration.  Thus,  a  corporation  receiving  $30,000 
in  dividends  in  1917,  $10,000  of  which  is  from  surplus 
earned  in  each  of  the  years  1914,  1915  and  1916,  will  pay 
1%  on  $20,000  (the  rate  for  1914  and  1915)  and  2%  on 
$10,000  (the  rate  for  1916). 

Dividends  Deemed  to  Be  from  Most  Recently  Ac- 
cumulated Profits  or  Surplus.  Any  distribution  made 
to  stockholders  in  1917,  or  thereafter,  shall  be  deemed, 
under  the  express  provisions  of  the  law,  to  have  been 
made  from  the  most  recently  accumulated  undivided 
profits  or  surplus.  This  provision  would  seem  to  have 
reference  to  the  profits  and  surplus  in  existence  at  the 
time  of  the  declaration  of  the  dividend,  and  not  the  time 
of  payment.  It  would  seem  that  a  dividend  declared 
in  the  current,  year  would  not  be  considered  to  be  out 
of  that  year's  earnings,  unless  the  books  of  a  corpora- 
tion, at  the  time  the  dividend  was  declared,  had  been 

13  Act  of  September  8,  1916,  §  31,  added  by  Act  of  October 
3,  1917. 


INCOME  PROM    DIVIDENDS  269 

closed  and  showed  undivided  profits  or  surplus  for  the 
current  year.  The  language  used  in  the  law  is  that 
the  dividends  "shall  be  deemed  to  have  been  declared 
from  the  most  recently  accumulated  undivided  profits 
or  surplus,"  regardless  of  what  the  actual  facts  may 
be.  Thus,  the  corporation  may  actually  intend  to  make 
a  distribution  in  the  form  of  dividends  out  of  some 
fund  other  than  the  most  recently  accumulated  profits 
or  surplus,  but,  nevertheless,  the  law  deems  such  pay- 
ment to  have  been  made  from  the  most  recently  accu- 
mulated profits  and  surplus  and  the  dividend  will  be 
taxable  on  that  basis.  This  provision  does  not  apply, 
liowever,  to  any  distribution  made  prior  to  August  6, 
If)  17,  out  of  earnings  or  profits  accrued  prior  to  March 
1.  UtlM.i* 

Dividends  from  Earnings  or  Profits  Accrued  Prior  to 
March  1st,  1913.  When  a  dividend  is  declared  from 
earnings  or  profits  accrued  prior  to  March  1st,  1913, 
the  recipient,  whether  individual  or  corporation,  is  liable 
for  no  tax  thereon.  Such  earnings  or  profits,  however, 
can  be  distributed  only  after  all  of  the  earnings  and 
profits  of  the  corporation  accrued  since  March  1st,  1913, 
have  first  been  distributed." 

14  Under  the  1916  Law,  the  Treasury  Department  ruled  that 
dividends  could  be  declared  from  any  specified  fund,  that  is,  a 
tlividend  could  be  declared  from  surplus  accumulated  prior  to 
March  1,  1913,  and  consequently  be  free  from  tax  in  the  hands  of 
the  stockholders,  although  the  corporation  had  surplus  and  un- 
divided profits  accumulated  since  that  date  sufficient  to  pay  the 
•lividend.  This  ruling  is  annulled  by  the  amendment  of  October 
,  1917,  except  as  indicated  in  the  text. 
16  Act  of  September  8,  191fi,  S  .31  added  by  Act  of  October  3, 
1917.  There  is  conflict  in  the  cises  under  the  1913  Law  as  to  the 
taxability  of  dividends  distributed  subsequent  to  the  incidence  of 


270  federal  income  tax 

Such  Dividends  Exempt  Only  to  Stockholders  of 
First  Corporation.  Where  dividends  are  declared  from 
surplus  accrued  prior  to  March  1,  1913,  they  are  free 
from  tax  in  the  hands  of  the  stockholder,  but  if  such 
stockholder  is  in  turn  another  corporation,  upon  the 
distribution  to  its  stockholders  of  the  sum  so  received 
as  dividends,  the  fund  becomes  taxable  to  the  stock- 
holders of  the  second  corporation  as,  to  the  holding 
company,  such  sum  did  not  represent  earnings  or  profits 
accrued  prior  to  March  1,  1913.  While  the  law  pro- 
vides for  the   exemption  of  dividends  from   corporate 

the  tax  from  earnings  which  accrued  prior  thereto,  the  law  being 
silent  on  that  point.  The  Circuit  Court  of  Appeals  declared  in 
the  case  of  Lynch  v.  Turrish,  236  Fed.  653,  that  a  sunr  received 
by  a  stockholder  in  excess  of  the  par  value  of  his  stock,  exclusively 
from  the  increase  in  value  of  his  stock  prior  to  March  1st,  1913, 
on  account  of  the  gradual  advance  in  the  value  of  the  property 
of  the  corporation  prior  to  that  date,  was  not  income  when  dis- 
tributed by  the  corporation  after  the  incidence  of  the  tax.  In  a 
case  decided  at  the  same  time,  Lynch  v.  Hornby,  236  Fed.  661,  the 
same  court  held  that  dividends  received  by  a  stockholder  from  the 
conversion  of  property  into  money  and  a  distribution  after  the 
incidence  of  the  tax  was  not  taxable  where  the  dividend  represented 
the  value  of  property  owned  by  the  corporation  on  March  1st,  1913, 
including  the  increase  of  the  value  of  its  timber  lands  and  surplus 
from  its  business  operations,  the  court  announcing  as  its  opinion 
that  no  property  held  by  the  corporation  or  the  stockholder,  whether 
original  capital  or  previously  earned  surplus  income,  gains  or 
profits,  was  intended  to  be  made,  or  was  made,  taxable  as  indome 
by  the  1913  law,  so  far  as  it  represented  the  value  of  such  property 
on  March  1st,  1913.  In  a  later  case.  Southern  Pacific  Company 
V.  Lowe,  238  Fed.  847,  the  District  Court,  for  the  southern  district 
of  New  York,  held  that  dividends  from  surplus  accumulated  prior 
to  March  1st,  1913,  were  not  taxable,  if  the  surplus  represented  an 
increase  in  the  value  of  the  assets  of  the  corporation,  but  were 
taxable,  if  the  surplus  was  accumulated  from  earnings  or  profits 
of  the  corporation  prior  to  the  incidence  of  the  tax.  The  question 
is  now  before  the  United  States  Supreme  Court  for  final  decision. 


INCOME  PROM   DIVIDENDS  271 

funds  earned  prior  to  March  1,  1913,  it  does  not  pro- 
vide for  tracing  the  identity  or  character  of  such  divi- 
dends after  the  receipt  thereof  by  the  stockholders  of 
the  corporation  which  earned  the  fund  prior  to  the 
incidence  of  the  tax.*® 

Dividends  Received  by  an  Estate.  Dividends  re- 
ceived by  an  estate  are  not  exempt  because  paid  from 
surplus  accrued  prior  to  the  creation  of  the  estate,  but 
are  taxable  as  are  dividends  received  by  other  tax- 
payers, that  is,  either  to  the  beneficiaries  if  the  income 
is  distributed,  or  to  the  estate  if  it  is  not  distributed," 
unless  the  dividends  were  declared  from  earnings  or 
profits  which  accrued  to  the  corporation  prior  to  March 
1,  1913. 

Dividends  from  Reserves  for  Depreciation  or  Deple- 
tion. It  is  the  practice  of  some  corporations  to  declare 
dividends  out  of  reservas  set  aside  to  meet  depreciation 
and  depletion.  Such  dividends  are  held  taxable  to  the 
stockholders  if  declared  out  of  reserves  accumulated 
since  March  1.  1913." 

Cash  Dividends.  Where  a  dividend  is  paid  in  cash, 
or  by  check,  which  is  the  equivalent  of  cash,  the  divi- 
dend becomes  taxable  to  the  recipient  in  the  year  in 
which  it  is  received,  not  necessarily  in  the  year  in 
which  it  is  declared.    In  such  cases  it  should  be  reported 

16  Letter  from  Treasury  Department  dated  July  23,  1917; 
I.  T.  S.  1917,  K  2277. 

17  Letter  from  Treasury  Department  dated  October  19,  1915; 
I.  T.  8.  1917,  ^  669.  The  principle  of  the  decision  in  Matter  of 
Osborne,  209  A.  D.  450  (N.  Y.)  was  referred  to  in  this  letter  and 
held  to  have  no  application  to  the  income  tax  law. 

18  T.  D.  2540. 


272  FEDERAL   INCOME   TAX 

as  income  for  the  year  in  which  the  cash  or  check  is 
received.^® 

Scrip  Dividends.  When  a  dividend  is  paid  in  scrip  it 
is  held  to  be  equivalent  to  a  payment  in  cash  and  an 
investment  of  the  cash  in  the  scrip.  The  dividend,  there-, 
fore,  must  be  included  in  the  return  at  the  face  value 
of  the  scrip.^  If  at  a  later  date  the  face  value  of  the 
scrip  is  not  realized  in  cash  a  loss  may  be  claimed  in 
,the  year  in  which  the  stockholder  parts  with  the  scrip. 

Dividends  Paid  in  Equivalent  of  Cash.  Very  few 
rulings  have  been  made  on  the  subject  of  distribution  of 
the  net  earnings  in  property  other  than  cash  or  stock 
of  the  corporation.  When  distribution  is  made  in  prop- 
erty which  has  no  fixed  money  value,  it  would  be  diffi- 
cult to  determine  the  amount,  if  any,  of  earnings  or 
surplus  in  such  distribution.  Although  the  law,  in  its 
definition  of  the  term  "dividends,"  expressly  states 
that  a  dividend  shall  be  a  payment  in  cash  or  in  stock 
of  the  corporation,  it  does  not  seem  to  be  the  intent 
thereof  that  no  tax  shall  accrue  if  the  payment  is  made 
in  the  equivalent  of  cash.  Where,  for  instance,  the 
corporation  uses  its  surplus  and  undivided  profits  in 
purchasing  securities  and  thereafter  distributes  such 
securities  among  its  stockholders  as  a  dividend,  it  would 

19  Letter  from  Treasury  Department  dated  February  18,  1915 ; 
I  T.  S.  1917,  If  178.  This  rule  is  not  changed  by  the  amendment 
of  October  3,  1917,  which  expressly  provides  that  in  the  case  of 
distribution  in  1917  or  subsequent  years  the  amount  distributed 
shall  be  considered  as  a  part  of  the  annual  income  of  the  dis- 
tributee for  the  year  in  which  it  is  received. 

20  Letter  from  Treasury  Department  dated  January  19,  1915; 
I.  T.  S.  1917,  H  168.  Scrip  dividends  were  held  taxable  under  the 
Act  of  June  30,  1864.    Bailey  v.  Railroad  Company,  106  U,  S.  109. 


INCOME  PROM   DIVroENDS  273 

seem  clear  that  the  value  of  the  securities,  either  at 
the  time  of  purchase  or  at  the  time  of  the  distribution, 
would  measure  the  money  value  of  the  dividend.  The 
time  at  which  the  corporation  acquired  the  securities 
would  seem  to  be  the  proper  time  at  which  to  determine 
the  money  value  of  such  a  dividend,  since  any  increase 
in  the  value  above  the  .cost  of  such  securities,  at  the 
time  of  distribution,  had  not  been  realized  as  earning 
or  profit  of  the  corporation,  and,  it  must  be  borne  in 
mind,  a  dividend  is  taxable  only  to  the  extent  that  it 
represents  earnings  or  profits  of  the  corporation. 

Dividends  Paid  in  Liberty  Bonds.  The  fact  that 
dividends  are  paid  in  Liberty  Bonds  does  not  make 
that  income  exempt  from  tax.  The  tax  is  upon  the 
income  itself  as  an  entirety  and  not  upon  the  specific 
articles  into  which  this  income  is  finally  transmuted. 
When  Liberty  Bonds  are  used  as  a  medium  of  payment, 
whether  in  discharge  of  a  private  debt  or  a  corporate 
dividend,  profit  or  gain  to  the  recipient  is  nevertheless 
subject  to  income  tax.** 

Taxes  Paid  for  Shareholders  to  Be  Considered  as 
Dividends.  Where  a  corporation,  such  as  a  bank,  pays 
taxes  assessed  upon  the  respective  interests  of  its  share- 
holders, under  laws  which  require  <he  corporation  to 
pay  such  taxes  on  behalf  of  its  shareholders,  the  pro 
rata  amount  so  paid  on  his  shares  should  be  reported 

81  Letters  from  Treasury  Department  dated  June  30,  1917,  and 
.Tune  22,  1917;  I.  T.  S.  1917.  112257  and  2258,  The  second  of 
these  letters  is  based  upon  .in  opinion  on  the  subject  obtaine<l 
from  the  Attorney  General  by  the  Treasury  Department.  The 
question  was  raised  by  reason  of  the  language  of  the  Act  authoriz- 
ing the  first  issue  of  Liberty  Bonds,  which  exempted  the  principal 
and  income  from  taxation. 
F.  I.  Tax.— 18 


274  FEDERAL   INCOME   TAX 

by  the  stockholder  as  a  dividend.  The  same  amount 
may  also  be  deducted  as  a  tax  of  the  stockholder  paid 
for  him  by  the  corporation  as  his  agent.  The  net  result 
of  reporting  such  amount  as  a  dividend,  and  claiming 
the  same  amount  as  a  deduction,  is  that  the  amount  of 
tax  is  offset  against  the  stockholder's  income  from  other 
sources  in  assessing  the  normal  tax.22 

Stock  Dividends.  The  1916  Law  expressly  provides 
that  stock  dividends  shall  be  taxable.  It  defines  a  stock 
dividend  as  a  distribution  by  a  corporation  out  of  its 
earnings  or  profits  accrued  since  March  1st,  1913,  and 
payable  to  its  shareholders  in  stock  of  the  corporation. 
It  also  provides  that  such  stock  dividends  shall  be  con- 
sidered income,  to  the  amount  of  the  earnings  or  the 
profits  so  distributed.^  A  stock  dividend  is  only  tax- 
able where  a  cash  dividend  would  be  taxable.  Any 
distribution  made  in  the  form  of  a  stock  dividend,  which 
would  not  be  taxable  if  made  in  the  form  of  a  cash 
dividend,  is  not  made  taxable  by  reason  of  the  distribu- 
tion being  made  in  stock. 

Rule  Under  1913  Law.  The  1913  Law  was  silent 
as  to  stock  dividends,  and  it  was  at  first  held  by  the 
Treasury  Department  that  such  dividends  were  not  sub- 
ject to  tax,  on  the  theory  that  the  additional  shares  of 
stock  issued  to  the  stockholder  represented  no  more 
than  the  same  interest  in  the  identical  property  repre- 
sented by  his  stock  before  the  dividend.    The  Treasury 

22  For  a  further  discussion  of  this  subject  see  Chapter  30  on 
Deduction  of  Taxes. 

23  Act  of  September  8,  1916,  §  31,  added  by  Act  of  October  3, 
1917.  The  1916  Law  prior  to  the  amendment  contained  substan- 
tially the  same  definition  of  stock  dividends. 


INCOME  PROM   DIVIDENDS  275 

Department  subsequently  changed  its  attitude  and  held 
stock  dividends  to  be  the  equivalent  of  cash  and  to  con- 
stitute taxable  income  under  the  same  conditions  as 
cash  dividends.**  Only  one  case  has  been  decided  under 
the  1913  Law,  and  in  that  case  the  District  Court  held 
a  stock  dividend  to  be  taxable.^  The  court  said  in  part : 
"I  can  give  little  weight  to  the  argument  that  the 
issue  of  a  stock  dividend  did  not  affect  the  market  value 
of  the  plaintiff's  aggregate  holdings  and  that  the  dis- 
tribution of  50%  more  stock  to  the  stockholders  lessened 
the  market  price  of  their  original  stock  33|^%.  This 
would  be  true  in  case  of  any  cash  dividend  extraordi- 
nary, or  even  ordinary.  The  cash  distributed,  plus  the 
market  value  of  the  stock  after  the  dividend  was  paid, 
would  ordinarily  be  equivalent  in  value  to  the  stock 
before  the  dividend.  But  the  objection  seems  impressive 
that  the  transaction  in  nowise,  affected  what  the  stock- 
holder already  had  except  to  give  him  additional  pieces 
of  paper  evidencing  his  ownership.  He  does,  however, 
have  something  different  before  and  after  receiving  the 
additional  stock.  What  was  before  a  mere  chance  that 
he  might  receive  his  share  of  the  surplus  in  cash  divi- 
dends, and  a  vague  right  to  secure  them  if  the  directors 
withheld  them  in  a  way  and  to  an  extent  that  indicated 
bad  faith,  is  now  converted  into  a  permanent  interest 
in  the  capitalized  surplus.  He  has  lost  the  chance  of 
cash  dividends  and  gained  an  interest  in  the  corporate 
enterprise  that  cannot  be  taken  away.     This  interest 

84  T.  D.  2274,  dated  December  22,  1915. 

86  Towns  V.  Eisner,  U.  S.  D.  C.  S.  D.  N.  Y.  242  Fed.  702.  In  this 
case  it  was  also  held  that  the  dividends  were  subject  to  tax  although 
declared  from  surplus,  all  of  which  was  earned  prior  to  January 
1,  1913,  and  paid  January  2,  1914.  The  case  is  now  before  the 
Supreme  Court  on  appeal. 


276  FEDERAL   INCOME   TAX 

is  derived  from  earnings  and  may  be  really  of  much 
greater  advantage  to  the  stockholder  than  the  possi- 
bility or  right  which  he  has  lost.  It  becomes  capital 
of  the  corporation,  but  in  his  hands  it  is  income  and 
in  many  respects  resembles  the  common  extraordinary 
cash  dividend  accompanied  by  a  right  to  subscribe  for 
additional  stock  at  par  to  an  amount  equivalent  to  the 
dividend  in  cash.  To  say  that  this  distribution  is  not 
income  because  he  received  no  cash  and  the  interme- 
diate step  is  not  taken  is,  to  my  mind,  quite  to  dis- 
regard the  real  nature  of  the  transaction.     * .  *     * 

"The  real  stumbling  block  which  affects  everyone 
*  *  *  is  the  taxation  of  very  large  accumulations 
of  earnings  distributed  by  corporations  after  the  passage 
of  the  Act.  pertainly  the  mere  matter  of  size  can  make 
no  difference  in  determining  whether  the  property 
taxed  is  income  or  not.  .The  doubt  I  have  felt  in  reach- 
ing my  conclusion  has  not  been  due  to  the  nature  of 
stock  dividends,  but  to  the  difficulty  *  *  *  i^  (de- 
termining whether  Congress  intended  to  tax  earnings 
at  all  which  had  accrued  in  the  han^s  of  the  corpora- 
tion prior  to  the  passage  of  the  Act,  but  were  distributed 
later."  The  1916  Law  "providing  that  a  cash  or  stock 
dividend  payable  out  of  earnings  since  March  1,  1913, 
shall  be  considered  income  has  no  bearing  upon  this 
case.  It  may  be  argued  that  it  was  a  limitation  or  an 
extension  of  the  income  taxable  by  the  Act  under  con- 
sideration, but  in  neither  event  can  it  be  held  to  define 
the  income  which  was  theretofore  taxable."*^ 

26  As  a  practical  matter  it  seems  absolutely  necessary  that  the 
law  should  tax  stock  dividends,  otherwise  the  supertaxes  could  be 
avoided  by  individuals  forming  corporations  to  hold  their  personal 
estates  and  reinvesting  the  earnings  from  year  to  year,  the  yearly 
surplus  in  each  case  being  converted  into  capital  by  a  distribution 
of  stock  dividends. 


INCOME   PROM   DIVTOENDS  277 

Money  Value  op  Stock  Dividend.  The  present  law 
provides  that  a  stock  dividend  shall  be  considered  income 
"to  the  amount  of  the  earnings  or  profits  so  distributed." 
Prior  to  the  amendment,  the  1916  Law  provided  that 
a  stock  dividend  should  be  taxable  "to  the  amount  of 
its  cash  value."  Both  phrases  are  construed  to  have 
the  same  meaning.  The  value  of  each  share  of  the 
stock  dividend,  for  the  purpose  of  the  income  tax,  is 
determined  by  dividing  the  amount  of  earnings,  profit, 
or  surplus  distributed,  by  the  total  number  of  shares 
constituting  the  stock  dividend.  In  other  words,  the 
amount  which  the  stockholder  would  have  received  had 
payment  been  made  in  cash,  is  the  amount  to  be  reported 
as  income.*''  The  par  value  of  a  stock  dividend  usually 
indicates  the  amount  to  be  reported  as  income.  The 
fact  that  the  stock  dividend  may  have  a  market  value, 
at  the  time  it  is  received  by  the  stockholder,  greater 
or  less  than  its  proportionate  value  as  a  part  of  the 
surplus  of  profits  distributed,  does  not  alter  the  rule. 
In  a  subsequent  sale  of  the  dividend  stock,  the  value 
at  which  it  was  reported  as  income  when  received  as 
a  dividend  is  to  be  considered  as  its  cost,  and  the  profit 
or  loss  realized  from  the  sale  should  be  figured  accord- 
ingly, as  in  the  case  of  any  other  sale  of  property.** 

87  Letter  from  Treasury  Department  dated  October  30,  1916; 
I.  T.  S.  1917,11164. 

8«  Letter  from  Treasury  Department  dated  March  24,  1916; 
I   T.  S.  1917,  1466. 


CHAPTER  24 

INCOME  FROM  ROYALTIES 

The  Treasury  Department  expressly  requires  that 
royalties  from  mines,  oil  wells,  patents,  franchises,  or 
other  legalized  privileges  shall  be  separately  reported  by 
the  individual,  but  not  by  corporations.  No  particular 
rules  have  been  issued  with  respect  to  royalties  and  with 
respect  to  income  from  royalties,  except  to  hold  that 
where  royalty  is  received  in  exchange  for  a  right  to  man- 
ufacture and  sell  an  article  under  a  patent,  the  amount 
of  the  royalty  received  is  income,^  In  the  case  of  mines 
operated  by  a  lessee  on  a  royalty  basis,  the  amount  of 
royalty  received  by  the  lessor  is  income.^ 

«> 
Royalties  from  Mines.  In  has  been  contended  that 
royalties  received  under  mining  leases  and  oil  leases  are 
in  fact  not  income  but  payments  of  instalments  on  the 
purchase  price  of  the  natural  deposit.  The  nature  of 
•such  leases  has  been  the  subject  of  some  difference  of 
opinion  in  the  courts.  It  has  been  held  that  the  leases 
are  such  in  name  only,  and  are  in  fact  conveyances  of  the 
ore  body  in  place  as  a  part  of  the  realty,  and  that  the 
so-called  royalties  merely  represented  payments  for  so 
much  land  and  were  in  no  just  sense  income,  but  mere 

1  Letter  from   Treasury  Department  dated  January  24,  1916; 
I.  T.  S.  1917,  f  1187. 
2T.  D.  2152. 

278 


INCOME   PROM   ROYALTIES  279 

conversions  of  the  capital.  On  the  other  hand,  it  has 
been  held  that  such  leases  do  not  constitute  a  sale  of 
any  part  of  the  land  and  further,  that  ores  or  other 
materials  derived  from  the  usual  operation  of  open  mines 
or  quarries,  constitute  the  rents  and  profits  of  the  land. 
The  United  States  Supreme  Court  in  a  case  arising 
under  the  1909  Law  reviewed  the  conflicting  authorities, 
and  held  that  under  the  language  of  that  law  royalties 
received  under  mining  leases  were  income.'  Under  the 
present  law  such  royalties  are  treated  as  income,  against 
which  the  owner  of  the  property  may  claim  an  allowance 
for  depletion  of  the  natural  resource. 

Royalties  from  Patents  and  Copjrrights.  Taxpayers 
receiving  royalties  from  patents,  copyrights,  or  other 
similar  forms  of  property,  may  deduct  from  each  pay- 
ment a  proportionate  part  of  the  cost  thereof  as  repre- 
senting, a  return  of  capital.  This  is  more  fully  diseussetl 
in  a  subsequent  chapter.* 

8  Von  Baurabach  v.  Sargent  Land  Company,  242  U.  S.  503. 
4  See  p.  294. 


CHAPTER  25 

INCOME  FROM  MISCELLANEOUS  SOURCES 

After  specifying  a  number  of  sources  of  income,  the 
act  provides  that  the  net  income  of  the  taxpayer  shall 
include  gains  or  profits  and  income  derived  from  any 
source  whatever.  In  this  chapter  are  set  forth  the 
rulings  on  income  from  sources  not  covered  by  the  pre- 
ceding chapters. 

Alimony.  Alimony  is  not  income,  as  it  does  not  arise 
from  any  business  transaction,  and  is  not  founded  on 
any  contract,  but  on  the  natural  and  legal  duty  of  the 
husband  to  support  the  wife.^  It  follows  that  the  hus- 
band cannot  deduct  the  amount  he  pays  as  alimony  from 
his  income  for  the  purpose  of  the  tax, 

r 

Accident  Insurance.  Money  paid  to  a  person  insured 
by  an  accident  insurance  policy,  on  account  of  accident 
sustained,  is  income  (to  the  extent  that  the  amount 
exceeds  the  aggregate  premiums  paid)  but  amounts  re- 
ceived from  a  railroad  company,  by  way  of  reimburse- 
ment for  expenses  incident  to  an  accident,  are  not  con- 
sidered income.  The  proceeds  of  accident  insurance 
policies  paid    to    an    individual   beneficiary,    upon   the 

1  Gould  V.  Gould,  U.  S.  Supreme  Court,  Case  No.  41,  October 
Term,  1917,  not  yet  officially  reported.  This  decision  reversed  the 
ruling  of  the  Treasury  Department. 

280 


INCOME  FROM    MISCELLANEOUS   SOURCES  281 

death  of  the  person  insured,' are  not  income  to  tiie  bene- 
ficiary.* 

Assessments  on  Stock.  Assessments  paid  by  stock- 
holders on  stock  are  not  income  of  the  corporation,  nor 
is  a  voluntary  contribution  on  the  part  of  the  stock- 
holders, to  make  good  a  deficit  of  the  corporation.* 

Damages.  An  amount  received  as  the  result  of  a  suit 
or  compromise  for  "pain  and  suffering"  is  held  to  be 
income.*  The  law  imposes  the  tax  on  income  from  all 
sources,  but  it  seems  unjust  to  tax  one  who  receives  in  a 
lump  sum  an  amount  as  damages  to  compensate  him  for 
a  period  of  years  on  account  of  disability  resulting 
from  injury.  In  other  words,  he  receives  several  years' 
income  at  one  time  and  the  supertax  takes  more  than  a 
just  portion  thereof,  while  the  law  does  not  even  permit 
him  to  deduct  the  expenses  of  surgical  and  medical  at- 
tendance from  the  gross  amount  of  damages  he  may 
receive. 

Increment  to  Sinking  Funds.  Where  a  sinking  fund 
is  set  aside  for  the  purpose  of  meeting  obligations  at  a 
future  date,  all  increment  to  that  fund  as  a  result  of 
investments  is  income  to  the  creator  of  the  fund.  Where 
a  sinking  fund,  controlled  by  trustees,  has  been  invested 
in  the  bonds  of  the  corporation  which  created  the  fund, 
and  the  corporation  pays  the  trustees  interest  on  such 
bonds,  the  amount  of  interest  may  be  deducted,  the  same 
as  payment  to  any  other  bondholders,  and  within  the 

8T.  D.  2135. 

S  Letter  from  Treasury  Department  dated  February  21,   191fi; 
1.  T.  S.  1917,  f  1196. 
4T.  D.  2135. 


282  FEDERAL   INCOME   TAX 

limitation  fixed  by  law,  but  the  same  amount  must  be 
included  as  income  to  the  corporation  from  the  sinking 
fund.^ 

Legacies.  A  legacy  is  a  gift  and  the  value  thereof 
is  not  considered  income  to  the  recipient,  but  all  income 
created  by  the  legacy  is  taxable.  Unless  clearly  incon- 
sistent with  the  intention  of  the  testator,  a  legacy  is 
held  to  be  vested  rather  than  contigent,  and  where  there 
is  a  vested  interest  the  income  therefrom,  whether  dis- 
tributed or  not  by  the  executor  or  administrator,  is  sub- 
ject to  the  tax  from  the  time  of  death  of  the  testator,  as 
income  of  the  legatee.® 

Pensions.  Pensions  paid  by  the  United  States  Gov- 
ernment are  subject  to  the  income  tax,''  as  also  are  pen- 
sions paid  by  any  other  government,  or  by  any  private 
interest,  under  any  contract  express  or  implied.  If, 
however,  a  so-called  "pension"  is  a  mere  gratuity  or 
gift  it  is  not  taxable  as  income  to  the  recipient. 

Proceeds  of  Life  Insurance  Paid  to  Individual 
Beneficiaries.  "When  the  proceeds  of  a  life  insurance 
jjoliey  are  paid  to  an  individual  beneficiary  upon  the 
death  of  the  insured,  the  amount  of  the  policy  is  exempt 
and  need  not  be  included  as  gross  income  of  the  indi- 
vidual,^ and  this  is  true  whether  the  payments  of  such 
proceeds  are  made  in  a  lump  sum  at  the  death  of  the 
insured,  or  in  instalments  thereafter,  or  as  annuities.® 
If  the  instalments  are  not  paid  in  accordance  with  the 

6  T.  D.  2161. 
6T.  D.  2090. 
7T.  D.  2090. 

8  Act  of  September  8,  1916,  §  4,  E«g.  33,  Art.  5. 

9  Letter  dated  December  29,  1913;   T.  T.  S.  1917,  If  301. 


INCOME  PROM    MISCELLANEOUS   SOURCES  283 

terms  of  the  policy,  but  under  agreement  made  between 
the  insurance  company  and  the  beneficiary,  any  amounts 
of  accretion  to  the  sura  payable  under  the  terms  of  the 
polic}'  will  be  taxable  as  income. 

Proceeds  of  Life  Insurajice  in  Favor  of  Corporations. 
Where  a  corporation  has  insured  the  life  of  an  officer 
or  employee  or  other  person  in  favor  of  the  corporation 
it  is  not  allowed  to  deduct  as  an  annual  expense  the 
amount  of  premium  paid,  but  such  annual  payments  of 
premium  will  be  considered  as  investment  of  capital  and, 
,  when  the  policy  is  paid  at  maturity,  the  aggregate 
amount  of  the  premiums  paid  during  the  term  of  the 
policy  may  be  deducted  from  the  proceeds  of  the  policy, 
the  remainder  being  income  for  the  year  in  which  it  is  re- 
ceived.*® 

Property  Acquired  by  Gift.  The  value  of  property 
acquired  by  gift,  bequest,  devise  or  descent  (but  not 
the  income  from  such  property)  is  exempt.  Such  prop- 
erty need  not  be  reported  as  income  by  the  recipient.*' 
It  was  held  under  the  1913  Law  that  gifts  to  corporations 
were  not  exempt,  but  this  ruling  does  not  apply  under 
the  1916  Law,  since  the  provision  of  the  former  law 
exempting  income  of  this  character  was  contained  in 
the  subdivision  applying  particularly  to  individuals, 
while  in  the  latter  it  is  placed  in  a  section  having  general 
reference  to  all  taxpayers.  It  would  seem  under  the 
present  law  that  income  of  this  character  is  exempt 
from  the  tax  regardless  of  the  status  of  the  recipient.** 

10  T.  D.  2519.  Act  of  September  8,  1916,  $  32,  added  by  Act 
of  October  3,  1917. 

11  Reg.  33,  Art.  5. 

l«  Compare  Act  of  October  3,  1913,  H  B  and  Act  of  September 
8,  1916,  S  4. 


i 


284  FEDERAL   INCOME   TAX 

Definition.  Christinas  presents,  gratuities,  volun- 
tary contributions  and  donations  are  considered  as  gifts 
and  should  not  be  reported  as  income  by  the  recipient. 
An  exception,  however,  is  made  in  the  case  of  clergymen ; 
Easter  offerings,  and  fees  received  by  them  for  funerals, 
masses,  marriages,  baptisms,  etc.,  while  in  the  form  of 
gifts,  are  in  fact  payment  for  services  and  should  be 
reported  as  income.^^  Special  payments  made  by  an 
employer  as  extra  compensation  to  employees  are  some- 
times called  bonuses  or  gifts,  but  if  made  as  compensa^ 
tion  for  services  rendered,  and  paid  in  pursuance  of  a 
contract,  express  or  implied,  they  are  in  fact  not  gifts  < 
but  income  from  services,  and  taxable  to  the  recipient.^* 
Where  the  salary  of  an  employee  is  paid  for  a  limited 
period  after  his  death  to  a  relative  /)r  dependent,  in 
recognition  of  the  services  rendered  by  the  employee, 
no  services  being  rendered  by  the  recipient,  the  payments 
are  gifts  and  exempt  from  taxation.**  Of  course,  any 
amount  paid  by  one  person  out  of  his  income  to  another, 
as  a  gift,  is  not  deductible  from  the  net  income  of  the 


giver 


16 


Sale  of  Property  Acquired  by  Gift.  When  prop- 
erty acquired  by  gift  is  thereafter  sold,  the  value  of  the 
property  at  the  time  the  gift  was  made  is  deducted  from 
the  amount  received  on  the  sale  thereof  and  the  remain- 
der is  taxable  as  income  of  the  seller. 

Recoveries  on  Bad  Debts.  Where  a  bad  account  has 
been  charged  off  to  profit  and   loss  and   subsequently 

13  T.  D.  2090. 

14  T.  D.  2152.  See  Chapter  17. 
16  T.  D.  2090,  Reg.  33,  Art.  6. 
16  See  Chayiter  27  on  Deductions. 


INCOME   FROM    MISCELLANEOUS   SOURCES  285 

the  money  is  recovered,  the  sum  so  recovered  must  be 
treated  as  income  whether  or  not  the  bad  debt  was 
charged  off  prior  to  the  incidence  of  the  tax  or  subse- 
quent thereto.  The  fact  that  a  bad  debt  has  been  charged 
off  prior  to  the  incidence  of  the  tax  does  not  make  it 
any  the  less  income  for  the  year  in  which  it  is  recov- 
ered." 

Rights  to  Subscribe  to  Stock.  Where  a  stockholder 
acquires  the  right  to  subscribe  to  new  stock  of  the  cor- 
l)oration  and  sells  that  right,  the  amount  received  is 
considered  as  income.*'  If  he  exercises  the  right,  no 
income  accrues  until  the  stock  subscribed  for  is  sold. 

IT  Letter  from  Treasury  Department  dated  February  11,  1916; 
T.  T.  S.  1917,  1(1163.  The  term  "incidence  of  the  tax"  means 
the  time  when  the  tax  first  applied  to  the  taxpayer.  Generally 
it  is  used  to  indicate  March  1,  1913. 

1*  Letter  from  Treasury  Department  dated  February  27,  1915 ; 
1.  T.  S.  1917,  I  287. 


CHAPTER  26 

RECEIPTS  WHICH   ARE  IN   PART  RETURN   OP   CAPITAL 

Income  is  not  synonymous  with  receipts.  The  tax  is 
on  income,  gains  and  profits.  The  true  function  of  the 
words  "gains"  and  "profits"  is  to  limit  the  meaning  of 
the  word  "income"  and  to  show  its  use  only  in  a  sense 
of  receipts  which  constitute  "gains"  and  "profits."  The 
increased  value  of  capital  as  such  constitutes,  in  one 
sense,  a  gain  or  profit,  but  does  not  constitute  income  un- 
til the  property  has  been  sold  or  disposed  of  for  cash  or 
its  equivalent.  When  so  sold,  the  entire  income  is  not 
gain  or  profit,  but  only  so  much  thereof,  according  to  the 
rulings  of  the  Treasury  Department,  as  the  selling  price 
exceeds  the  cost  of  such  property.  In  an  early  case  it 
was  said  that  "income  is  that  which  capital  earns  re- 
maining itself  intact. ' '  ^  Often  receipts  represent  a 
change  of  capital  investment  or  a  distribution  of  capital 
assets.  In  that  case  there  is  no  gain  or  profit.  If  such 
receipts  were  regarded  as  income  the  taxpayer's  capital 
would  be  depleted.^  The  law  does  not  attempt  to  tax 
such  receipts,  as  is  evidenced  by  the  language  of  the 
section  (under  the  somewhat  misleading  head  of  exempt 
income)   which  provides,  among  other  things,  that  the 

1  People  V.  Davenport,  30  Hun.  177.  This  definition  was  adopted 
in  Mitchell  v.  Doyle,  225  Fed.  437,  and  is  in  substance  what  the 
court  held  in  Southern  Pacific  Company  v.  Lowe,  238  Fed.  847,  and 
in  the  cases  cited  in  that  opinion. 

8  Lynch  v.  Hornby,  236  Fed.  661;  Lynch  v.  Turrish,  236  Fed- 
653. 

286 


RECEIPTS   WHICH   ABE  PART  RETURN   OP   CAPITAL,     287 

amount  received  by  the  insured,  as  a  return  of  premium 
or  premiums  paid  by  him  under  life  insurance,  endow- 
ment, or  annuity  contracts,  either  during  the  term  or  at 
the  maturity  of  the  term  mentioned  in  the  contract,  or 
upon  the  surrender  of  the  contract,  is  exempt.*  The 
further  provisions  of  the  law  holding  that  gain  derived 
from  the  sale  or  other  disposition  of  property  acquired 
before  March  1st,  1913,  shall  be  taxed  only  to  the  extent 
that  it  is  measured  by  the  difference  between  the  fair 
market  price  or  value  of  such  property  as  of  March  1st, 
1913,  and  the  selling  price,  indicate  that  Congress  did 
not  intend  to  tax  any  income,  gain  or  profit,  or  growth 
of  capital,  which  took  place  prior  to  March  1st,  1913. 
Whatever  growth  took  place  in  the  capital  of  the  tax- 
payer up  to  that  date,  and  whatever  amounts  such 
capital  had  earned  prior  to  that  date,  became  capital 
on  that  date,  so  far  as  the  income  tax  law  is  concerned. 
Another  provision  evidencing  this  intent  is  that  which 
expressly  provides  that  dividends  from  earnings  or 
profits  accrued  to  a  corporation  prior  to  March  1st,  1913, 
shall  not  be  taxable  on  distribution  to  the  shareholders. 
The  Treasury  Department,  in  the  main,  follows  this 
principle,  but  deviates  from  it  in  some  respects  as,  for 
instance,  in  the  case  of  depreciation,  where  it  requires 
the  annual  depreciation  allowance  to  be  based  upon  the 
original  cost  of  the  property  whether  acquired  before  or 
after  March  1st,  thus  denying  to  the  taxpayer  a  return 
of  the  full  value  of  his  capital  on  March  1st,  1913,  in 
cases  where  the  value  of  his  property  increased  between 
the  time  it  was  originally  purchased  and  that  date.  In 
most  cases  it  is  a  comparatively  simple  matter  to  divide 
leceipts  into  two  parts,  one  representing  return  of  capital 
(which  is  not  taxable)  and  the  other  representing  income 

S  Act  of  September  8,  1916,  §  4. 


288  FEDERAL   INCOME   TAX 

(which  is  taxable)  as  the  following  rules  will  indicate. 
Difficulty  sometimes  arises  in  segregating  capital  and  in- 
come in  the  case  of  instalment  payments  for  goods  sold 
in  the  course  of  business.  The  rulings  which  have  been 
issued  by  the  Treasury  Department  indicate,  however,  a 
method  which  might  be  adopted  in  handling  such  pay- 
ments, as  more  fully  appears  in  a  later  part  of  this 
chapter. 

Dividends  on  Life  Insurance  Policies.  Dividends 
paid  on  life  insurance  policies  that  have  not  matured, 
whether  or  not  such  dividends  are  drawn  in  cash  by  the 
insured  or  applied  to  the  reduction  of  the  annual 
premium  due,  are  not  considered  items  of  taxable  in- 
come. Dividends  from  paid-up  policies,  however,  are 
considered  income.  The  former  represent  merely  a  re- 
turn of  a  part  of  the  premium  theretofore  paid  by  the  in- 
sured, while  the  latter  represent  a  distribution  of  income 
earned  by  the  insurance  companies  on  the  premiums 
paid  by  the  insured,  and,  when  paid  to  the  insured, 
should  be  treated  the  same  as  dividends  from  corpora- 
tions.* 

Surrender  Value  of  Insurance  Policies.  When  an 
insured  person  discontinues  insurance  prior  to  the  ma- 
turity of  his  policy,  he  is  entitled  to  a  certain  surrender 
value  which  is  paid  to  him  by  the  insurance  company. 
The  amount  so  received  represents  the  return  to  the  in- 
sured of  a  part  of  the  premiums  he  has  paid  in  the  past, 
and  is  therefore  not  income.  If  the  amount  should  ex- 
ceed the  aggregate  of  premiums  paid,  the  excess  would 
be  taxable  income.^ 

4T.  D.  2137. 

6  T.  D.  2090,  as  amended  by  T,  D.  2152.  Letter  from  Treasury 
Department  dated  February  8,  1917;  T.  T.  S.  1917,  112002. 


BECEIPTS  WHICH  ARE  PABT  RETURN  OP  CAPITAL     289 

Endowment  Policies.  Where  an  endowment  policy- 
is  paid  to  the  insured,  it  is  exempt  from  tax  to  the 
extent  that  the  payment  represents  a  return  to  the  in- 
sured of  amounts  paid  by  him  from  time  to  time  as 
premiums,  but  is  taxable  on  the  excess,®  Thus,  if  over 
a  period  of  years  the  insured  has  paid  $700  in  premiums, 
and,  at  the  expiration  of  the  term  receives  $1,000  from 
the  insurance  company,  $300  of  that  sum  is  taxable  in- 
come, but  the  $700,  representing  return  of  premiums, 
is  not  income. 

Annuities.  So  much  of  annuities  paid  to  an  annui- 
tant as  represents  payment  made  by  him  on  the  annuity 
contract,  is  not  taxable  income.  Any  increment  on  the 
purchase  price  of  the  annuity  is  taxable  income.''  The 
Trea.sury  Department  has  not  prescribed  any  rules  for 
determining  what  part  of  each  payment  of  an  annuity 
is  income  and  what  part  represents  return  of  principal. 
In  the  case  where  one  has  purchased  a  life  annuity  it 
seems  the  annuitant  should  be  permitted  to  deduct  an- 
nually a  part  of  the  purchase  price  determined  perhaps 
by  dividing  the  total  purchase  price  of  the  annuity  by 
tlie  number  of  years  of  his  expectation  of  life,  as  shown 
!»>'  the  insurance  mortality  tables,  at  the  time  of  pur- 
chase. Thus  if  the  expectation  of  life  is  fifteen  years, 
the  purchase  price  should  be  divided  by  fifteen  and  only 
so  much  of  the  annuity  as  exceeds  this  sum  each  year  can 
reasonably   be   said   to   be   income  to  such   annuitant. 

Matured  Shares  in  Building  and  Loan  Association. 
AVhere  the  amount  paid  back  to  a  depositor  by  a  building 

«T.  D.  2090,  as  amended  by  T.  D.  2152. 

7  Letter  from   Treasury  Department  dated  January   12,   1914; 
I.  T.  S.  1917,  1  306. 
P.  I.  Tax.— 19 


290  FEDERAL   INCOME   TAX 

or  loan  association,  at  the  maturity  of  the  series,  exceeds 
the  aggregate  deposits  made  to  that  series,  only  the 
defference  between  the  total  amount  received  for  the 
surrender  of  the  matured  certificate  and  the  aggregate 
of  the  deposits  made  by  the  certificate  holder,  is  to  be 
returned  as  income.® 

Compensation  by  Insurance.  Insurance  money  is 
clearly  a  substitute  for  the  assets  lost  or  destroyed.  The 
money  so  received  from  the  insurance  company  is  not 
income,  but  a  direct  compensation  for  the  property  lost, 
and  it  is  expressly  provided  by  the  law  that  no  loss  can 
be  claimed  for  property  destroyed  when  such  loss  is 
compensated  for  by  insurance.* 

Timberlands.  The  value  of  timberlands  at  the  inci- 
dence of  the  tax  may  be  deducted  pro-rata  as  the  lumber 
is  cut  and  sold  in  that  such  value  represents  the  capital 
of  the  owner,^*^  The  Treasury  Department  has  published 
several  rulings  describing  the  procedure  to  he  followed 
in  claiming  annual  allowances  for  the  return  of  capital 
in  the  case  of  owners  of  timber  properties,  which  are 
summarized  in  the  following  paragraphs. 

Basis  of  Allowance.  Owners  of  timberland  logging 
off  the  timber  and  manufacturing  it  into  lumber  will  be 
permitted  to  exclude  from  gross  income,  either  through 
a  deduction  from  gross  receipts  or  through  a  charge  into 
the  cost  of  manufacturing  the  timber  into  lumber,  an 
amount  equivalent  to  the  fair  market  price  or  value  of 

8  Letter  from  Treasury  Department  dated  February  8,  1917;  I. 
T.  S.  1917,  H  2000. 

9  Act  of  September  8,  1916,  §§  5  and  12. 

10  Doyle  v.  Mitchell,  235  Fed.  686. 


I 


KECEIITS   WHICH    ARE    PART    RETURN   OP   CAPITAL      291 

the  Standing  timber  as  of  March  1,  1913,  if  the  property 
was  acquired  prior  to  that  date  or  the  actual  cost,  that 
is,  the  gross  purchase  price  of  the  timber  property,  if 
purchased  subsequent  to  that  date.** 

Fair  Market  Value  as  op  March  1,  1913.  The  fair 
market  value  of  timber  or  timberlands  as  of  March  1, 
1913,  is  the  price  at  which  the  property,  in  its  then  con- 
dition and  with  the  circumstances  then  surrounding  it, 
could  have  been  sold  for  cash  or  its  equivalent.  The 
value  must  not  be  speculative,  but  must  be  determined 
without  taking  into  account  any  prospective  profit  that 
may  result  from  the  manufacture  of  the  timber  into 
lumber.  It  must  be  as  the  law  contemplates,  a  fair  mar- 
ket value,  and,  once  determined,  must  be  set  up  on  the 
books.  As  the  measure  of  a  stumpage  deduction  for  in- 
come tax  purposes,  it  must  remain  constant  and  cannot 
be  increa.sed.  The  department  does  not  specifiy  any  par- 
ticular method  of  arriving  at  the  fair  market  price  or 
value  as  of  March  1,  1913,  but  requires  the  owner  to 
determine  the  amount  which,  in  his  opinion,  is  the  fair 
market  price  or  value  as  of  that  date,  and  to  calculate 
his  deduction  on  that  basis.  The  amount  so  determined 
by  the  owner  will  be  given  due  consideration,  and,  if  at 
a  later  date  it  appears  to  the  Treasury  Department  that 
it  does  not  represent  the  fair  market  price  or  value,  the 
owner  will  be  advised  and  be  given  an  opportunity  to 
present  reasons  and  facts  as  to  why  the  figures  should  be 
accepted. 

Gross  PurchaseI  Price.  If  the  property  is  purchased 
-subsequent  to  March  1.  1913,  the  Treasury  Department 

H  Letter  from  Treasurj-  Department  dated  March  3,  1917;  I. 
T.  S.  1917,  n  2164  and  2165. 


292  .  FEDERAL   INCOME  TAX 

will  allow,  as  the  basis  of  the  annual  deduction,  an 
amount  representing  the  original  cost  of  such  timber  plus 
any  carrying  charges  that  may  have  been  capitalized  or 
not  deducted  from  income,  the  purpose  being  to  secure 
to  the  owner,  when  the  timber  has  been  exhausted,  an 
aggregate  amount  which,  plus  the  salvage  value  of  the 
land,  will  equal  the  capital  actually  invested.^^ 

Procedure  in  Claiming  Annual  Allowance.  After 
determining  the  value  of  the  property  as  of  March  1, 
1913,  or  its  cost,  if  purchased  subsequent  to  that  date, 
the  number  of  feet  (board  measure)  in  the  entire  timber 
holdings  should  be  estimated.  By  dividing  the  original 
cost  or  value  by  this  number,  the  per  unit  value  or  price 
will  be  ascertained.  This  per  unit  value  multiplied  by 
the  number  of  feet  of  timber  removed  each  year  will 
measure  the  annual  deduction,  which  may  be  made  until 
the  aggregate  amount  equals  the  amount  of  capital  in- 
vested. When  the  capital  has  been  so  extinguished,  the 
entire  amount  thereafter  realized  from  the  logged  off 
lands,  or  from  other  salvage,  will  be  returned  as  income 
of  the  year  in  which  the  timber  or  the  lands  are  sold  or 
disposed  of.  If  the  timber  or  timberlands  are  sold  en 
hloc  the  gain  or  loss  will  be  ascertained  on  the  basis  of 
the  difference  between  the  fair  market  price  or  cost  (less 
any  amounts  which  have  been  deducted  as  return  of 
capital)  and  the  selling  price,  according  as  the  property 
was  acquired  before  or  after  March  1,  1913.*^ 

Instalment  Payments.  Where  real  estate  is'  sold  on 
a  monthly  instalment  basis  under  a  contract  which  vests 

18  Eeg,  33,  Arts.  139  and  140. 

13  Letter  from  Treasury  Department  dated  March  3,  1917 ;  I. 
T.  S.  1917,  III  2164  and  2165. 


RECEIPTS   WHICH    ARE   PART  RETURN   OP   CAPIT.VL      293 

possession  of  the  property  in  the  vendee,  but  explicitly 
retains  title  in  the  vendor  and  provides  for  reversion  to 
liini  in  case  of  default  on  the  terms  of  the  contract,  it 
has  been  held  that  every  dollar  received  under  the  con- 
tract represents  in  part  a  return  of  a  portion  of  the 
cost  of  the  property  to  the  vendor  and  in  part  a  portion 
of  the  total  profit  to  be  derived  from  its  sale,  and  that 
the  amount  of  profit  represented  should  be  taken  into 
consideration  in  computing  gain  or  profit  during  the 
year  for  income  tax  purposes.  Thus|  where  the  cost  of 
the  property  is  $250  and  is  sold  for  $450,  four-ninths 
of  the  selling  price  represents  the  profit  and  that  fraction 
of  each  instalment  payment  should  be  returned  as  gross 
income,  against  which  the  vendor  may  claim  allowable 
deductions.  If  under  the  terms  of  the  contract  a  de- 
fault in  payment  occurs,  and  the  vendor  retains  all  pay- 
ments received,  as  liquidated  damages,  the  vendee  losing 
all  right  and  title  to  the  property  and  to  the  amount  of 
payments  made,  the  entire  amount  theretofore  re(feived 
and  treated  as  a  •return  of  capital,  should  be  included 
as  income  for  the  year  during  which  the  default  occurs.^* 
This  seems  to  be  a  logical  method  to  follow  in  every  case 
of  payments  by  instalment  for  goods  or  property  sold 
in  the  ordinary  course  of  business,  as  it  distributes  the 
income  over  the  entire  period  during  which  payment  is 
being  made.  On  the  other  hand,  the  selling-price  may  be 
treated  as  a  receipt  in  the  year  in  which  the  goods  are 
sold,  subsequent  instalment  payments  being  treated  %is 
partial  payments  of  debts  and  unpaid  instalments  being 
treated  as  worthless  debts  in  the  year  they  are  ascer- 
tained to  be  a  loss.  The  segregation  of  capital  and  in- 
come in  each  instalment  payment  has  the  advantage, 

14  Letter  from  Treasury  Department  dated  March  14,  1917;  I. 
T.  8.  1917,  ^  2215. 


294  FEDERAL   INCOME  TAX 

I 

however,  of  taxing  the  income  or  profit  from  the  sale  in 
the  year  in  which  it  is  actually  received. 

Royalties  from  Patents.  An  allowance  for  return  of 
capital,  in  the  case  of  one  receiving  royalties  from 
patents,  is  permitted  on  the  following  basis.  The  deduc- 
tion for  exhaustion  of  capital  assets  represented  by  the 
patents  should  be  each  year  one-seventeenth  of  the  actual 
cost  of  such  patents.  Where  the  patent  has  been  secured 
from  the  Government,  by  the  taxpayer  claiming  the  de- 
duction, its  cost  would  represent  the  various  government 
fees,  cost  of  drawings,  experimental  models,  attorneys' 
fees,  and  other  expenses.  Where  the  patent  has  been 
purchased  for  a  cash  consideration,  the  purchase  price 
represents  the  cost.  Where  a  corporation  has  purchased 
a  patent  and  made  payment  therefor  in  its  own  stock 
or  other  securities,  the  actual  cash  value  of  such  stock 
or  other  securities  at  the  time  of*purchase  will  represent 
the  cost.^*  Where  depreciation  at  this  rate  has  been 
claimed  for  one  or  more  years  and  the  value  of  the  patent 
disappears,  through  obsolescence  or  any  other  cause,  in 
a  subsequent  .year,  the  unretumed  cash  investment  re- 
maining in  the  patent  may  be  claimed  as  a  total  loss 
and  be  deducted  from  the  income  of  that  year.^^  Where 
a  patent  is  purchased  after  it  is  partially  expired  thr 
cost  of  the  patent  may  be  divided  by  the  number  of  years 
of  life  of  the  patent  remaining  at  the  date  of  purchase. 
Thus,  for  instance,  if  a  patent  has  ten  years  to  run  at  the 
time  of  purchase,  one-tenth  of  the  cost  may  be  deducted 
each  year.^'^ 

15  Reg.  33,  Art.  137. 

16  Reg.  33.  Art.  138. 

17  Letter  from  Treasury  Department  dated  September  24,  1915; 
T.  T.  S.  1917,  111414. 


RECEIPTS   WHICH    ARE   PART   RETURN   OP    CAPITAL      295 

Royalties  from  Copyrights.  Allowance  for  return  of 
capital  invested  in  copyrights  may  be  taken  by  the  owner 
of  the  copyright  in  the  same  manner  as  stated  above  in 
the  case  of  patents,  taking  the  life  of  the  copyright  as 
the  divisor,  the  cost  as  the  dividend,  and  the  result  as 
the  amount  of  the  annual  allowance. 

Royalties  from  Lease  of  Natural  Deposits.  In  the 
case  of  mines,  oil  wells,  and  gas  wells,  the  law  provides 
expressly  for  methods  of  determining  the  annual  allow- 
ance for  depletion.    See  the  Chapters  on  Depletion.^* 

18  See  Chapters  33  and  34. 


CHAPTER  27 

DEDUCTIONS — IN   GENERAL 

In  determining  the  net  taxable  income  of  an  individ- 
ual or  a  corporation  certain  deductions  are  specified  in 
the  law.  While  the  deductions  allowed  both  corpora- 
tions and  individuals  are  based  upon  the  same  principles 
they  vary  in  some  particulars,  due  to  differences  in  the 
status  of  the  two  classes  of  taxpayers.  Thus,  the  corpor- 
ation may  deduct  the  ordinary  and  necessary  expenses 
paid  within  the  year  in  the  maintenance  and  operation 
of  its  business  and  properties,  while  an  individual  may 
only  deduct  the  necessary  expenses  actually  paid  in 
carrying  on  any  business  or  trade,  not  including  per- 
sonal living  or  family  expenses.  On  the  other  hand,  an 
individual  may  deduct  all  interest  paid  within  the 
year  (subject  to  one  exception  applicable  to  both  indi- 
viduals and  corporations)  while  a  corporation  is  limited 
to  a  deduction  of  interest  paid  on  indebtedness  not  ex- 
ceeding one  half  of  its  total  indebtedness  plus  the 
amount  of  its  capital  stock  outstanding.  Again,  all 
losses  sustained  by  a  corporation  during  the  year  may 
be  deducted  but  in  the  case  of  individuals,  losses  in- 
curred in  transactions  entered  into  for  profit  not  con- 
nected with  the  taxpayer's  business  or  trade  may  be  de- 
ducted only  to  an  amount  not  exceeding  the  profits  aris- 
ing from  such  transactions.  In  the  case  of  corporations 
and  individuals  the  allowance  for  depreciation  is  limited 

296 


DEDUCTIONS — IN   GENERAL  297 

to  property  used  in  the  business  or  trade  of  the  tax- 
payer, but  in  the  case  of  corporations  the  amount  must 
be  actually  ^'charged  off."  Taxes  paid  during  the  year 
may  be  deducted  to  the  same  extent  by  both  individuals 
and  corporations.  In  the  ease  of  non-resident  aliens 
and  foreign  corporations  the  deductions  are  intended  to 
be  limited  to  such  expenses,  losses,  etc.,  as  are  incurred 
in  the  creation  of  the  income  which  is  taxed  by  this  Gov- 
ernment. The  special  provisions  applicable  to  individ- 
uals, corporations,  non-resident  aliens  and  foreign  cor- 
porations are  set  forth  in  the  chapters  dealing  respec- 
tively with  those  subjects.  The  general  provisions  appli- 
cable to  all  taxpayers  are  discussed  in  this  and  the  fol- 
lowing chapters. 

Only  the  Deductions  Specified  in  the  Statute  Are 
Allowed.  It  must  be  borne  in  mind  that  although  the 
tax  is  imposed  on  the  net  income  of  a  taxpayer,  yet 
the  net  income  so  taxed  is  that  which  is  specifically 
defined  in  the  statute,  and  not  that  which  may  be  gen- 
erally termed  net  income  in  accounting  practice  or 
recognized  as  such  by  custom.  There  may  be,  for 
instance,  many  deductions  dictated  by  prudence  and 
good  business  management  which  are  not  recognized 
or  countenanced  by  the  law.  Only  those  deductions 
which  are  expressly  specified  in  the  statute  may  be 
taken   for  income  tax  purposes. 

Deductions  Must  Be  Actual.  The  deductions  specified 
in  the  statute  can  be  deducted  by  the  taxpayer  only 
in  case  they  represent  actual  payments  or  actual  lia- 
bilities. It  is  not  permissible,  for  instance,  for  a  tax- 
payer owning  the  property  used  and  occupied  for  his 
or  its  own  business  purposes  to  include  as  a  deduction 


298  FEDERAL   INCOME   TAX 

the  rental  value  of  the  property  so  owned.  Neither 
is  it  permissible  to  deduct  an  amount  representing  the 
interest  which  might  be  earned  on  the  capital  employed 
in  the  business,  if  such  capital  were  invested  or  employed 
otherwise,  or  so  placed  as  to  earn  a  given  rate  of  inter- 
est.^ Primarily  the  deductions  claimed  in  any  year 
must  be  those  represented  by  actual  cash  disbursements 
on  the  part  of  the  taxpayer  unless  the  taxpayer  has 
chosen  to  report  on  some  other  basis  than  that  of  actual 
receipts  and  disbursements. 

Reporting  Deductions  According  to  Book  Entries. 
Where  an  individual  or  a  corporation,  keeping  accounts 
upon  any  basis  other  than  that  of  cash  receipts  and 
disbursements,  has  elected  to  report  his  or  its  net  income 
according  to  such  basis,  and  is  permitted  by  the  Treas- 
ury Department  to  do  so,  both  the  income  and  the  author- 
ized deductions  must  be  computed  and  accounted  for 
on  the  same  basis,  and  the  same  practice  must  be  con- 
sistently followed  year  after  year.  When  deduction  is 
made  of  the  amounts  accrued  or  reserved,  a  further 
deduction  cannot  be  made  when  the  actual  liability  or 
obligation  is  paid.  In  so  far  as  the  accrual  or  reserve 
is  sufficient  to  meet  the  liability  it  must  be  charged 
against  the  fund  created  to  meet  it.  If  it  is  found 
upon  investigation  that  returns  made  upon  the  basis 
of  accruals  and  reserves  do  not  reflect  the  true  net 
income,  the  taxpayer  will  not  thereafter  be  permitted 
to  make  returns  upon  any  basis  other  than  that  of 
actual  receipts  and  disbursements.^     The  Treasury  De- 

1  T.  D.  2137. 

2  T.  D.  24.33.  Although  this  Treasury  Decision  refers  expressly 
to  corporations,  and  not  to  individuals,  and  no  similar  rules  have 
been  prescribed  with  respect  to  the  latter,  there  seems  to  be  no 


I 


DEDUCTIONS — IN   GENERAL  299 

partmeut  has  always  held,  in  the  case  of  corporations, 
that  it  was  immaterial  whether  deductions,  except  for 
taxes  and  losses,  were  evidenced  by  actual  disburse- 
inents  in  cash,  or  evidenced  in  such  other  ways  as  to 
be  properly  acknowledged  by  the  corporate  officers  and 
so  entered  on  the  books  of  the  corporation  as  to  con- 
stitute a  liability  against  the  assets.  Except  as  the 
same  may  be  modified  by  the  provisions  of  the  act, 
limiting  certain  deductions  and  authorizing  others,  the 
net  income  as  returned  by  a  corporation  for  the  pur- 
pose of  the  tax  should  be  the  same  as  that  shown  by 
the  books  or  the  annual  balance  sheet.'  No  special 
system  of  bookkeeping  has  been  required,  nor  any  spe- 
cific method  prescribed  in  rulings  or  regulations  by 
which  the  net  income  should  be  determined.*  As  to 
taxes,  the  Department  held  in  the  past  that  the  tax 
must  be  actually  paid,  and  not  merely  entered  as  a 
charge,  in  order  to  be  deducted,  and  in  the  case  of 
losses  the  loss  must  be  actually  sustained  and  not 
merely  charged  oflf.  As  to  taxes,  the  rule  seems  to  be 
changed  in  the  case  of  corporations  electing  to  report 
according  to  their  books,  as  indicated  in  the  following 
paragraph. 

Accruals,  Corporations  which  accrue  on  their  books, 
monthly  or  at  other  stated  periods,  amounts  sufficient 
to  meet  fixed  annual  or  other  charges,  may  deduct 
from  their  gross  income  the  amount  so  accrued,  pro- 
vided such  accruals  approximate  as  nearly  as  possible 

reason  why  an  individual  should  not  be  permitted  to  avail  himself 
of  the  same  privilege  of  reporting  on  a  basis  other  than  that  of 
actual  receipts  and  disbursements,  since  the  law  extends  the 
privilege  to  both  in  identical  language. 

3  Reg.  33,  Art  158. 

«T.  D.  2161. 


300  FEDERAL   INCOME  TAX 

the  actual  liabilities  for  which  the  accruals  are  made, 
and  provided  that  in  cases  wherein  deductions  are  made 
on  the  accrual  basis,  income  from  fixed  and  determinable 
sources  accruing  to  the  corporation  is  returned,  for  the 
purpose  of  the  tax,  on  the  same  basis." 

Reserves  to  Meet  Liabilities,  Where  pursuant  to 
the  consistent  practice  of  accounting  of  a  corporation, 
or  pursuant  to  the  requirements  of  the  Interstate  Com- 
merce Commission  or  of  any  federal,  state  or  municipal 
supervising  authority,  corporations  set  up  and  main- 
tain reserves  to  meet  liabilities,  the  amount  of  which, 
and  the  date  of  payment  or  maturity  of  which  is  not 
definitely  determined  or  determinable  at  the  time  the 
liability  is  incurred,  the  amount  credited  to  such  reserves 
may  be  deducted,  provided  the  amounts  deductible  on 
account  of  the  reserves  approximate  as  liearly  as  can 
be  determined  the  actual  amounts  which  experience 
has  demonstrated  will  be  necessary  to  discharge  the 
liabilities  incurred  during  the  year,  for  the  payment 
of  which  additions  to  the  reserves  are  made.  If  it  is 
found  that  the  amount  credited  to  any  such  reserve 
is  in  excess  of  the  reasonable  or  probable  needs  for 
which  the  reserve  was  created,  the  excess  will  be  dis- 
allowed as  a  deduction  and  restored  to  income  for  the 
purpose  of  the  tax.  In  no  event  will  sinking  funds 
or  other  reserves  set  up  to  meet  additions,  betterments 
or  other  capital  obligations  be  allowed  as  deductions. 
Reserves  to  meet  losses  contingent  upon  shrinkage  in 
values,  losses  from  bad  debts,  losses  from  capital  invest- 
ments, etc.,  are  not  allowed  as  deductions,  since  such 
losses  are  only  deductible  when  definitely  determined 

6  T.  D.  2433. 


DEDUCTIONS — IN  GENERAL  301 

as  a  result  of  a  closed  or  completed  transaction  and 
actually  charged  oflf.® 

Additions  and  Betterments.  The  law  provides  ex- 
pressly in  the  case  of  individuals  and  corporations  that 
no  deduction  shall  be  allowed  for  any  amount  paid  out 
for  new  buildings,  permanent  improvements,  or  better- 
ments made  to  increase  the  value  of  any  property  or 
estate,  and  no  deduction  shall  be  made  for  any  amounts 
of  expense  in  restoring  property  or  making  good  the 
exhaustion  thereof  for  which  an  allowance  is  or  has 
been  madeJ  Amounts  expended  for  additions  and  bet- 
terments are  considered  as  a  capital  investment.*  Thus, 
expenditures  of  a  railroad  for  sidings  or  spur  tracks 
are  additions  and  betterments  and  therefore  not  deduct- 
ible,® If  expenditures  are  made  for  permanent  improve- 
ments and  betterments  they  are  treated  as  any  other 
investment  of  capital,  that  is,  if  the  asset  in  which  the 
capital  is  invested  is  one  on  which  depreciation  may  be 
claimed,  the  amount  expended  for  the  permanent  addi- 
tion or  betterment  is  added  to  the  cost  of  the  property 
for  the  purpose  of  determining  the  annual  depreciation 
allowance  thereafter.  The  statute  merely  intends  to  pro- 
hibit the  deduction  of  the  entire  amount  in  the  year  in 
which  the  expenditure  is  made. 

Public  Utilities.  In  a  decision  under  the  1909  Law 
it  was  held  that  the  fact  that,  under  the  laws  of  Cali- 
fornia, a  public  utilities  corporation  is  not  the  owner 

eT.  D.  2433. 

7  Act  of  September  8,  1916,  {§5,  6  and  12. 
•  Reg.  33,  Art.  118. 

9  Grand  Rapids  and  Indiana  Railway  Company  t.  Doyle,  T.  D. 
2210. 


302  FEDERAL    INCOME    TAX 

of  the  property,  but  merely  intrusted  with  the  use 
thereof,  did  not  entitle  it  to  more  favorable  treatment 
than  other  corporations.  ]\Ioney  received  from  the  con- 
sumers to  pay  for  service  connections  to  be  laid  in  public 
streets  was  held  t,o  be  income  on  which  the  corporation 
was  liable  to  pay  a  tax,  notwithstanding  that  all  or 
nearly  all  of  the  sums  so  received  may  have  been  ex- 
pended in  betterments  and  extension  of  its  system. 
Moneys  expended  for  service  connections  and  pipe 
extensions  are  invested  in  permanent  improvements, 
and  do  not  jcome  within  any  of  the  permitted  classes  of 
deductions  mentioned  in  the  statute.^"  They  are  not 
in  the  nature  of  improvements  made  merely  to  facili- 
tate the  transaction  of  a  growing  business,  the  expenses 
of  which  have  been  held  deductible.^^ 

Expense  of  Restoring  Property.  Expense  of  restoring 
property  or  making  good  the  exhaustion  thereof  is  not 
an  allowable  deduction  where  a  depreciation  allowance 
is  or  has  been  made  for  the  purpose,  that  is,  where  an 
annual  allowance  has  been  claimed  for  depreciation  of 
property  subject  to  wear  and  tear,  the  expense  of  restor- 
ing such  property  may  not  again  be  deducted,  but  must 
be  taken  out  of  the  sum  so  set  aside  for  depreciation. 

Voluntary  Destruction  of  Property.  Losses  due  to 
voluntary  removal  of  buildings,  etc.,  incident  to  improve- 
ments, are  not  allowed  as  a  deduction.     It  is  presumed 

10  Union  Hollywood  Water  Co.  v.  Carter,  238  Fed.  329.  It  would 
seem,  however,  that  it  is  unjust  in  a  case  like  this  to  tax  the 
company  on  its  receipts  where  the  money  is  for  improvements  and 
betterments  to  property  which  it  does  not  own. 

11  See  Mutual  Benefit  Life  Ins.  Co.  v.  Herold,  198  Fed.  199, 
referred  to  in  Chapter  28. 


DEDUCTIONS — IN   GENERAL  303 

that  depreciation  up  to  the  time  of  the  removal  has  been 
covered  by  previous  depreciation  charges  and  the 
residuary  value  of  the  building  removed  is  considered 
a  part  of  the  cost  of  the  new  building,  that  is,  as  a 
capital  investment  to  be  added  to  other  items  of  cost\ 
on  the  aggregate  of  which  depreciation  of  the  new 
building  may  be  based. ^* 

Special  Assessments  for  LocaJ  Benefits.  The  law  ex- 
pressly provides  that  assessments  against  local  benefits 
shall  not  be  deducted  as  taxes,  although  frequently 
referred  to  as  taxes  and  imposed  by  local  governments. 
Such  assessments  as,  for  instance,  for  paving,  curbing, 
installing  sewage  and  water  systems,  etc.,  are  held  to 
be  expenditures  which  add  to  the  value  of  the  property 
and  should  be  capitalized,  that  is,  added  to  the  cost  of 
the  property  for  the  purpose  of  determining  the  loss 
or  gain  in  a  subsequent  sale  of  such  property.** 

18  Reg.  33,  Art.  127. 

18  Letter  from  Treasury  Department  dated  December  22,  1914 ; 
I.  T.  S.  1917,  H  1342.     See  Chapter  20. 


CHAPTER  28 

DEDUCTION  OF  BUSINESS  EXPENSES 

The  law  permits  to  individuals  the  deduction  of  the 
necessary  expenses  actually  paid  in  carrying  on  any 
business  or  trade  (limited  in  the  case  of  non-resident 
aliens  to  business  conducted  within  the  United  States) 
and  in  the  case  of  corporations  all  the  ordinary  and 
necessary  expenses  paid  within  the  year  in  the  main- 
tenance and  operation  of  the  business  and  properties 
of  the  corporation,  including  rentals  or  other  payments 
required  to  be  made  as  a  condition  to  the  continued 
use  or  possession  of  property  to  which  the  corporation 
has  not  taken,  or  is  not  taking,  title,  or  in  which  it  has 
no  equity  (limited  in  the  case  of  foreign  corporations 
to  business  and  property  within  the  United  States). 
The  special  provisions  applicable  to  each  of  these  four 
classes  of  taxpayers  are  discussed  in  the  chapters  on 
citizens  and  residents,  non-resident  aliens,  corporations 
and  foreign  corporations,  respectively.  The  discussion 
in  this  chapter  is  limited  to  the  rules  applying  generally 
to  all  taxpayers.  As  a  general  rule,  the  expenses  which 
may  be  deducted  are  those  necessary  for  the  creation 
of  the  income  which  is  taxed.  It  should  be  noted,  how- 
ever, that  the  language  of  the  law  contains  some  express 
limitations,  which  are  more  fully  discussed  in  the  fol- 
lowing paragraphs. 

Deductions  Not  to  Be  Duplicated.  Where  a  deduction 
may,  or  should  be,  claimed  as  one  of  the  items  spe- 

304 


DEDUCTION  OP   BUSINESS  EXPENSES  305 

eifically  stated  in  the  law,  such  deduction  should  not 
also  be  included  under  the  head  of  business  expense. 
Thus,  where  a  deduction  is  claimed  for  depreciation, 
or  loss,  the  same  amount  should  not  also  be  deducted 
as  expense,  or  if  the  cost  of  tools  or  small  articles  has 
been  charged  to  expense,  depreciation  should  not  be 
claimed  thereon,  as  it  would  result  in  allowing  the  same 
deduction  twice.  Interest  paid  by  a  corporation  con- 
stitutes a  separate  deduction  and  should  not  be  taken 
into  account  as  a  part  of  the  cost  of  manufacture.* 

Expenses  Incurred  in  Earning  Exempt  Income.  -Ex- 
penses incurred  in  earning  income  which  is  not  subject 
to  tax  do  not  constitute  allowable  deductions  in  com- 
puting net  income  from  other  sources  which  are  taxable.* 

Expenses  of  Operation.  Expenses  of  operation  in- 
clude all  expenditures  for  material,  labor,  fuel,  and 
other  items  entering  into  the  cost  of  the  goods  sold 
or  inventoried  at  the  end  of  the  year,  and  all  other 
expenses  incurred  in  the  operation  of  the  business, 
except  such  as  are  required  by  the  act  to  be  segregated 
in  the  return,'  or  have  been  considered  in  determining 
the  cost  of  purchases  during  the  year.  Payments  for 
labor  and  materials  which  go  into  the  actual  operating 
of  a  railroad  and  its  properties  are  deductible.* 

Cost  of  Manufacturing  Products.  One  engaged  in 
manufacturing  may  include  as  an  element  of  the  cost  of 
manufactured  products,  the  cost  of  raw  material,  the 

1  T.  D.  2137. 
8  T.  D.  2137. 
3  Reg.  33,  Art.  114. 

*  Grand  Rapids  &  Indiana  Ry.  Co.  v.  Doyle,  T.  D.  2210. 
F.  I.  Tax.— 20 


306  FEDERAL   INCOME  TA^ 

cost  of  labor  of  the  men  who  actually  work  on  such  prod- 
ucts as  well  as  the  cost  of  supervisory  labor  such  as  that 
of  foremen,  inspectors,  overseers,  etc.,  provided  such  ex- 
penditures are  not  separately  deducted  from  gross  income 
in  the  return  of  annual  net  income.^  This  ruling  permits 
certain  items  of  wages  and  salaries  to  be  included  in  the 
cost  of  the  manufactured  product,  or  to  be  separately 
listed  as  labor,  wages,  commissions,  etc.  The  items 
however,  should  not  be  listed  under  both  heads,  as  this 
Would  constitute  double  deduction  of  the  amounts. 

Sums  Expended  for  Materials  Used  and  on  Hand. 

Where  a  business  carries  materials  and  supplies  on 
hand  for  use,  the  cost  thereof,  to  be  included  as  an 
expense  for  the  year,  should  be  only  the  amount  paid  for^ 
the  materials  which  are  actually  disbursed  and  used  in 
operation  during  the  year.®  Amounts  expended  for 
materials  to  be  used  in  subsequent  years  are  proper  de- 
ductions in  the  year  in  which  the  materials  are  used. 

Commissions.  Commissions  paid  to  a  real  estate 
agent  for  collecting  rents  and  managing  property  are 
allowed  as  a  business  expense  to  the  owner.  Commis- 
sions paid  to  salesmen  as  a  part  of  the  expense  of  con- 
ducting business  are  also  allowed  as  deductions.'' 

Commissions  Paid  in  Stock.  Commissions  allowed  to 
salesmen,  paid  in  stock,  are  deductible  as  an  expense, 
if  so  charged  on  the  books,  at  the  actual  value  of  such 
stock.' 

6  T.  D.  2152. 

6  Reg.  33,  Art.  123. 

7T.  D.  2090. 

8  Beg.  33,  Art.  117. 


DEDUCTION    OF   BUSINESS  EXPENSES  '{O? 

Entertainment  Money.  '  So-called  spending  or  treat- 
ing money  actually  advanced  by  business  enterprises 
to  their  traveling  salesmen,  as  a  part  of  the  selling  ex- 
pense of  their  product,  is  a  proper  deduction.  There 
must,  however,  be  some  showing  that  all  of  the  allow- 
ance claimed  as  a  deduction  was  actually  expended  for 
the  purpose  for  which  the  allowance  was  made,  namely, 
the  selling  of  the  product  in  question.* 

Contributions  for  Cajnpaign  Expenses.  Such  contri- 
butions, and  sums  of  money  expended  for  lobbying  pur- 
poses, are  held  not  to  be  ordinaiy  and  neces.sary  expenses 
of  corporations  and  are  therefore  not  deductible.*® 

Customs  Duties.  Customs  duties  may  be  either  de- 
ducted as  taxes  or  may  be  included  as  a  part  of  the  cost 
price  of  the  goods,  if  the  taxpayer  is  engaged  in  the 
importation  of  goods  and  merchandise.**  Such  duties 
of  course  should  not  be  both  included  as  cost  of  the  goods 
and  deducted  as  taxes. 

Discounts.  Discounts,  other  than  bank  discounts  on 
notes  executed  by  a  corporation,  were  required,  under 
the  1909  Law,  to  be  segregated  from  the  interest  item 
on  the  return  and  to  be  included  under  expenses." 

Accounts  Payable.  Accounts  payable  actually 
charged  into  the  expense  account  and  so  entered  on  the 
books  as  to  constitute  a  liability  against  the  assets  af 

9T.  D.  2090. 

10  T.  D.  2137. 

11  Letter  from  Treasury  Department  dated  Decemher  22.  1914; 
1.  T.  S.  1917,  11358. 

18  T.  D.  167.5. 


308  FEDERAL   INCOME   TAX 

the  company,  and  so  treated  in  the  preparation  of  the 
return  of  annual  net  income  that  they  will  not  be  in- 
cluded in  the  deductions  of  the  year  in  which  they  are 
actually  paid,  may  be  deducted  from  the  gross  income 
of  the  year  in  which  the  expenses  were  incurred.  This 
ruling  applies  only  to  accounts  payable  representing 
ordinary  and  necessary  expenses  of  maintaining  and 
operating  the  business,  that  is,  such  expenses  as  are 
incurred  in  producing  the  gross  income  which  it  is  re- 
quired to  return.^^ 

Expenses  of  Maintenance.  Maintenance  means  the 
upkeep  or  preserving  of  -the  condition  of  the  property  to 
be  operated  and  does  not  mean  additions  to  the  equip- 
ment, additions  to  the  property  or  improvements  of 
former  condition  of  the  property.^*  Expenses  of  main- 
tenance are  deductible. 

Improvements.  In  the  case  of  a  railroad  where  old 
rails  are  replaced  with  new  and  heavier  rails,  wooden 
bridges  and  culverts  with  concrete  and  steel  bridges  and 
culverts,  the  rule  is  that  the  cost  of  renewals  with  like 
kind  and  quality  is  allowable,  but  excess  cost  is  not 
allowable  as  a  deduction.^^ 

Repairs.  Incidental  repairs  made  to  the  business 
property  of  a  taxpayer  which  neither  add  to  the  value  of 
the  property  nor  appreciably  prolong  its  life,  but  keep 
it  in  an  operating  condition,  are  expense.^^    Incidental 

18  Letter  from  Treasury  Department  dated  March  2,  1915;  I.  T, 
S.  1917,  U  1267. 

14  Grand  Eapids  &  Indiana  Ey.  Co.  v.  Doyle,  T.  D.  2210. 
16  Grand  Rapids  &  Indiana  Ry.  Co.  v.  Doyle,  T.  D.  2210. 
16  Reg.  33,  Art.  131. 


DEDUCTION   OP   BUSINESS  EXPENSES  309 

repairs  are  only  those  repairs  which  will  not  if  con- 
tinued, as  the  component  parts  wear  out  and  are 
restored,  make  permanent  the  property.  Expenditures 
for  replacing  worn  out  parts  such  as  gears,  bolts, 
nuts,  valves,  etc.,  so  long  as  such  replacements  are  not 
pursued  to  the  extent  of,  and  for  the  purpose  of,  finally 
restoring  the  machinery  or  equipment  as  a  whole,  con- 
stitute incidental  repairs  and  are  deductible  as  operating 
expenses.  In  addition,  depreciation  on  the  property 
so  repaired  may  be  claimed  in  order  to  replace  the  ma- 
chinery, equipment  or  building  when,  as  an  entirety,  it 
is  worn  out  or  is  worthless  for  the  purpose  for  which 
it  is  intended.*"'^ 

Office  Furniture  ajid  Equipment.  An  ordinary  amount 
expended  for  renewal  of  oifice  furniture  and  equipment, 
and  charged  to  expense,  was  held  not  to  be  invested  in 
assets,  but  to  be  a  proper  expense  of  maintenance  of  the 
business  of  an  insurance  company,  which  it  was  entitled 
to  deduct  in  ascertaining  its  taxable  net  income  under 
the  1909  Law.  The  company  had  expended  in  one  year 
$1,213  for  ordinary  renewals  of  office  furniture,  in 
another  year  !i!l,370,  and  an  additional  sum  of  $1,808 
for  ordinary  renewals  of  attendants'  uniforms,  door  mats, 
window  shades,  awning,  small  hardware,  oils  and  other 
articles  of  like  character  and  also  the  sum  of  $2,244  for 
ordinary  renewals  of  office  equipment,  consisting  of 
lamps,  alterations  of  fixtures,  shades,  meters,  fans,  plugs, 
wirings,  etc.,  and  these  expenditures  were  no  greater 
than  the  average  of  similar  expenditures  for  other  years 
and  did  not  exceed  5%  of  the  cost  of  all  the  plaintiff's 
existing  furniture  and  equipment  similar  to  the  articles 

17  Letter  from  Treasury  Department  dated  September  19,  1916; 
I.  T.  S.  1917,  HI  1363  and  1364. 


310  FEDERAL   INCOME  TAX* 

detailed,  and  none  of  the  items  was  considered  in  the 
corporation's  books  or  statement  as  assets  because  of 
their  rapid  depreciation.  It  was  held  that  the  articles 
mentioned  were  of  a  perishable  and  transient  nature, 
and  properly  charged  to  expense  of  maintenance,  since 
they  apparently  did  no  more  than  maintain  in  proper 
condition  and  repair  the  ordinary  equipment  of  office 
furniture  and  supplies.^* 

Expenditures  for  Alterations.  In  the  case  of  a  com- 
pany which  expended  approximately  $5,000  for  altera- 
tions in  its  home  office,  apparently  solely  with  a  view  of 
facilitating  the  carrying  on  of  its  business,  it  was  held 
under  the  1909  Law  that  such  amount  was  properly 
deducted  as  an  expense.  The  Court  said  in  part:  "It 
should  be  remembered,  also,  that  in  these  days  of  up-to- 
date  business  method  requirements  it  often  becomes 
necessary  for  business  concerns  to  change  the  lay-out 
and  appointments  of  the  places  wherein  they  carry  on 
business,  with  a  view  to  economy  in  space,  a  saving  of 
unnecessary  labor,  and  the  bettering  of  working  condi- 
tions of  employees,  to  the  end  that  a  net  saving  of  run- 
ning expenses  will  result.  In  view  of  the  consistent 
expansion  of  the  plaintiff's  business,  which  the  evidence 
shows,  it  would  seem  that  the  amount  expended  for 
the  changes  made  in  the  office  ought  not,  under  the  cir- 
cumstances, to  be  considered  unreasonable  or  unusual, 
and  that,  therefore,  the  amount  claimed  might  well 
have  been  allowed  as  an  item  of  deduction.  It  seems 
to  the  court  that  business  concerns,  in  matters  of  this 
kind,  should  be  allowed  a  reasonable  discretion,  and  the 
law  so  enforced  as  to  help  rather  than  to  hinder  them 
in  making  reasonable  progress  in  the  development  of 

18  Mutual  Benefit  Life  Ins.  Co.  v.  Herold,  198  Fed.  199. 


DEDUCTION   OF   BUSINESS  EXPENSES  311 

their  business,  for  it  must  appear  to  anyone  giving  the 
matter  a  moment's  consicleration  thai  the  more  success- 
ful a  business  the  larger  the  results,  even  from  the  stand- 
point of  taxes  accruing  to  the  government."/* 

Payment  in  Lieu  of  Rental.  Where  a  leasehold  is 
purchased  and  paid  for  in  one  sum  at  the  beginning 
of  the  lease  the  amount  so  paid  may  be  divided  by  the 
number  of  years  constituting  the  life  of  the  lease  and  a 
deduction  made  annually  of  a  proportionate  amount, 
such  item  to  be  claimed  as  a  payment  made  in  lieu  of 
rental. «o 

Repairs  and  Improvements  Made  by  a  Tenant. 
Where  a  lease  requires  the  tenant  to  make  all  necessary 
repairs  or  improvements,  which  repairs  or  improve- 
ments revert  to  the  landlord  at  the  expiration  of  the 
lease,  the  tenant  may  charge  the  cost  of  all  such  repaii-s 
and  improvements  to  the  expense  of  doing  business.  If 
tlie  improvements  are  somewhat  penuanent  in  character, 
the  expense  should  not  be  all  deducted  in  one  year,  but 
should  be  pro-rated  over  the  number  of  years  constituting 
the  term  of  the  lease,  and  the  amount  deductible  from 
gross  income  of  each  year  would  be  the  aliquot  part  of 
such  cost.  **  Taxes  or  other  expenses  paid  by  the  tenant 
for  the  landlord  should  be  deducted  by  the  tenant  as 
expense. 

Cost  of  Buildings  Erected  by  Tenant  Under  Terms 
of  Lease.    AVhere,  under  the  terms  of  a  rental  or  lease 

19 Connecticut  Mutual  Lifo  Ins.  Co.  v.  Eaton,  218  Fed.  206. 

80  Letter  from  Treasniry  Department  dated  Fehniary  27,  1917: 
I.  T.  S.  1917,  112068. 

81  T.  D.  2137. 


312  FEDERAL   INCOME   TAX 

contract,  a  tenant  agrees  to  erect  a  building,  or  to  ex- 
pend during  the  rental  period  a  certain  fixed  sum  in 
making  improvements  upon  the  freehold,  it  is  held  that 
the  building  or  permanent  improvements  become  a  part 
of  the  realty,  unless  otherwise  agreed  upon  between  the 
contracting  parties.  As  the  use  of  the  building  or  per- 
manent improvement  by  the  tenant,  during  the  term  of 
the  lease,  is  a  part  of  the  consideration  of  the  contract, 
the  cost  of  such  buildings  or  improvements  may  be 
pro-rated  by  the  tenant  over  the  leased  term  and  be 
deducted,  at  an  annual  rate,  as  a  part  of  the  necessary 
expenses  actually  paid  in  carrying  on  any  business  or 
trade.  The  tenant  may  also  deduct  the  cost  of  incidental 
repairs  and  piaintenance  to  such  buildings  and  improve- 
ments,^^  If  the  building  is  erected,  or  permanent  im- 
provements are  made  after  the  lease  is  partially  expired, 
the  cost  thereof  may  be  divided  by  the  number  of  years 
the  lease  then  has  to  run,  and  if  the  life  of  the  lease  is 
longer  than  the  estimated  life  of  the  building  or  im- 
provements, the  cost  may  be  divided  by  the  number  of 
years  such  building  or  improvements  are  expected  to 
last,  instead  of  the  number  of  years  constituting  the 
life  of  the  lease.  ^ 

Insurance  Premiums.  Where  premiums  are  paid  for 
insurance  on  property  used  for  business  purposes,  or 
rented  or  leased  to  secure  an  income,  the  amount  so  paid 
constitutes  an  allowable  deduction.^ 

Life  Insurance  Premiums.  Premiums  paid  on  life 
insurance  policies  covering  the  lives   of  officers,    em- 

22  T.  D.  2442,  Reg.  33,  Art.  115. 

23  Letter  from  Treasury  Department  dated  February  27,  1917; 
I.  T.  S.  1917,  H  2064. 

24  T.  D.  2090. 


DEDUCTION   OP   BUSINESS  EXPENSES  313 

ployees,  or  those  financially  interested  in  any  trade  or 
business  conducted  by  an  individual,  partnership,  or 
corporation  may  not  be  deducted  as  a  part  of  the  annual 
expenses.** 

Premium  on  Fidelity  Bond.  Where  an  employee  is 
required  to  furnish  a  bond  and  pay  the  premium 
thereon,  as  a  necessary  incident  to  his  employment,  the 
amount  so  paid  may  be  deducted  by  him  as  an  expense.** 
If  the  employer  pays  the  premium  it  may  be  included 
in  his  business  expense. 

Reserves  for  Insurance.  Funds  set  aside  by  a  cor- 
poration for  insuring  its  own  property  are  not  a  proper 
deduction  as  a  business  expense,  but  any  loss  actually 
sustained  may  be  deducted  although  actually  paid  out  of 
a  fund  so  set  aside.*' 

Salaries.  As  a  general  rule,  it  may  be  stated  that 
any  salary  paid  in  good  faith  under  contract,  express 
or  implied,  for  services  actually  rendered  is  an  allow- 
able deduction  as  a  business  expense  of  the  employer. 
Inordinate  salaries  paid  by  an  individual  employer  to 
relatives  or  others  would  no  doubt  be  disallowed  on 
the  ground  that  they  were  not  paid  in  good  faith,  and 

25  Act  of  September  8,  1916,  S  32,  added  by  Act  of  October  3, 
11»17.  Prior  to  the  passage  of  this  provision  it  was  held  by  the 
Treasury  Department  that  such  premiums  were  deductible  (T.  D. 
2090)  but  later  this  ruling  was  reversed  and  it  was  held  there- 
after that  premiums  were  not  deductible  (T.  D.  2519,  dated 
August  30,  1917).  It  seems,  from  the  language  of  this  latter 
Treasury  Decision,  that  it  is  not  intended  to  have  a  retroactive 
effect  for  years  prior  to  1917. 

26  T.  D.  2090. 

27  Reg.  33,  Art.  122. 


314  FEDERAL   INCOME   TAX 

were  in  effect  a  method  of  distributing  income  so  as 
to  avoid  the  supertaxes.  In  the  case  of  corporations, 
any  salary  paid  to  an  employee  who  is  not  a  stock- 
holder would  be  a  proper  deduction  unless  the  payment 
could  be  attacked  for  lack  of  good  faith.  Where  the 
employee  is  also  a  stockholder,  the  salary  deduction 
will  be  scrutinized  with  greater  care,  and  in  such  cases 
it  is  important  that  the  following  rules  be  observed: 
(a)  the  services  must  be  actually  performed;  (b)  the 
amount  must  be  no  more  than  a  fair  and  reasonable 
compensation  for  services  rendered,  and  (e)  the  com- 
pensation should  not  depend  upon  the  employee's  inter- 
est in  the  corporation  as  a  stockholder,  or  vary  from 
year  to  year  with  the  earnings  of  the  corporation.** 
Under  the  1909  Law  it  was  held  that  in  addition  to 
the  foregoing  rules  it  was  necessary  that  the  salary  paid 
to  an  officer  who  was  also  a  stockholder  should  be 
authorized  by  the  board  and  made  a  matter  of  record 
on  the  minute  book  of  the  corporation,  in  order  to  be 
an  allowable  deduction,''^  but  this  has  not  been  required 
by  any  ruling  under  the  present  laws.  It  seems  reason- 
able that  an  officer  or  employee  of  a  corporation  should 
be  entitled  to  compensation  for  the  services  he  actually 
performs,  in  addition  to  his  dividends  as  a  stockholder, 
since  as  a  stockholder  he  is  under  no  duty  to  devote  any 
part  of  his  time  to  the  business  of  the  corporation. 
What  constitutes  a  reasonable  salary  is  a  question  of 
fact,  and  it  would  seem  that  a  fair  criterion  is  the 
amount  which  similar  services  would  command  if  the 
officer  or  employee  were  not  a  stockholder,  or  which  he 
could  get  by   rendering  the  same  services  to  another 

28  T.   D.   2152 ;    letter   from   Treasury   Department   dated    Feb- 
ruary 2,  1915;  I.  T.  S.  1917,  111284. 

29  T.  D.   1742. 


DEDUCTION   OF   BUSINESS  EXPENSES  315 

employer.  When  the  sum  paid  him  exceeds  such  amount, 
the  question  will  arise  as  to  the  propriety  of  deducting 
the  salary  as  a  business  expense.  It  is  conceivable,  of 
course,  that  an  individual  may  render  services  of  great 
value  to  a  corporation  of  which  he  is  the  chief  stock- 
holder, and  if  such  services  can  be  shown  to  be  reason- 
ably worth  the  salary  paid,  the  courts  will  probably 
sustain  the  deduction  as  a  proper  expense,  but  the  bur- 
den would  be  upon  the  corporation  to  prove  that  the 
payment  was  not  compensation  based  on  stockholding. 

Compensation  Based  on  Stockholding.  Where 
amounts  paid  as  compensation  or  additional  compen- 
sation to  officers  or  employees  are  based  upon  the  stock 
holdings  of  such  officers  or  employees,  such  amounts 
are  not  allowed  to  be  deducted  as  a  business  expense, 
but  are  held  to  be  dividends  even  though  paid  in  lieu 
of  salaries  or  wages.*®  Where  a  company  was  composed 
of  two  stockholders  who  divided  the  net  profits  between 
them,  calling  it  compensation,  it  was  held  that  the  money 
paid  out  was  equivalent  to  a  dividend  and  must  be 
treated  as  such.'^ 

Salaries  Paid  to  Enlisted  Men.  A  corporation  con- 
tiiiuing  to  pay  an  employee  his  salary,  or  part  thereof, 
during  his  services  in  the  United  States  Army  is  per- 
mitted to  deduct  the  amount  as  an  expense.'* 

Bonus  and  Profit  Sharing  Payments.  Special  pay- 
ments made  by  u  rorporation  as  extra  compensation  to 

30  Reg.  33,  Art.  119. 

SlJacobfl  and  Davies  (Inc.)  v.  Anderson,  228  Fed.  505,  T.  D. 
2262. 

38  Letter  from  Treasury  Department,  dated  October  4,  1910; 
r.  T.  S.  1917,  H  1286. 


316  FEDERAL   INCOME   TAX 

certain  of  its  employees  may  be  deducted  as  an  expense, 
if  it  is  clearly  shown  that  such  payments  are  made  as 
compensation  for  services  rendered  and  are  paid  in  pur- 
suance of  a  contract,  express  or  implied.^^  If,  however, 
there  is  no  contractual  relation  between  the  employee 
and  the  employer  by  reason  of  which  the  employee  could 
enforce"  his  claim  for  the  additional  compensation,  such 
payments  will  be  held  to  be  gratuities  and  not  allow- 
able as  expense.^*  Such  payments  as  extra  compensa- 
tion, when  added  to  the  salary  received  by  the  employee, 
^ust  not  exceed  a  reasonable  compensation  for  the  serv- 
ices rendered.  A  long  time  practice  regularly  employed 
of  paying  the  employees  certain  sums  in  addition  to 
the  stipulated  salaries  constitutes  a  condition,  if  not 
a  contract,  under  which  the  employees  may  reasonably 
expect,  for  the  greater  or  better  service  which  they 
render,  additional  pay,  and'  if,  in  fact,  such  payments 
are  made  as  additional  compensation  for  services 
actually  rendered  and  are  reasonable  in  amount  they 
may  be  treated  as  expense.  The  payments  must  be  con- 
ditioned upon  the  services  rendered  by  the  employees, 
and  not  upon  the  earnings  of  the  corporation.  If 
dependent  upon  the  earnings  of  the  corporation,  rather 
than  upon  the  services  rendered,  or  if  such  payments 
are  made  only  occasionally,  and  then  at  the  option  of 
the  corporation  as  a  sort  of  a  thank-offering  because 
of  a  prosperous  year,  the  payments  will  be  held  to  be 
gratuities.^^ 

Gifts  or  Gratuities  to  Employees.     Gifts  or  gra- 
tuities made  by  an  employer  to  his  employees  are  not 

S3  T.  D.  2152. 

34  Letter    from    Treasury    Department    dated    June    25,    1914; 
I.  T.  S.  1917,  1 1293. 

36  Mimeograph  letter  to  collectors  No.  1314. 


DEDUCTION   OP   BUSINESS  EXPENSES  317 

proper  deductions  as  an  expense.  Even  where  such  a 
payment  is  called  extra  compensation,  if  it  is  a  gratuity 
or  voluntary  payment  for  which  no  service  is  rendered, 
its  character  as  a  gift  is  not  changed.  The  custom  of 
paying  bonuses  or  Christmas  gifts  to  employees,  even 
though  it  has  been  the  practice  of  the  employer  for  a 
long  time  to  make  such  gifts,  does  not  make  the  amount 
so  paid  proper  deductions  as  expense  so  long  as  the 
gifts  are  voluntary  and  gratuitous.'® 

Pensions.  Amounts  paid  as  pensions  to  retired  em- 
ployees, or  their  families,  or  others  dependent  upon 
them,  or  paid  on  account  of  injuries  received  by 
employees,  are  ordinary  and  necessary  expenses,^''  but 
where  the  salary  of  an  employee  is  paid  foi*  a  limited 
period  after  his  death  to  a  relative  or  dependent,  in 
recognition  of  the  services  rendered  by  the  employee, 
no  service  being  rendered  by  the  recipient,  the  pay- 
ment is  held  to  be  a  gratuity,  and  not  allowed  as  an 
expense  of  the  business.'' 

Donations.  Donations  by  business  concerns  may  or 
may  not  be  held  to  be  proper  deductions  as  expense. 
There  must  be  a  consideration  in  some  form  to  take 
the  donation  out  of  the  class  of  gratuities.  It  has  been 
held  that  a  corporation  engaged  in  the  agricultural 
l)usiness  cannot  be  allowed  to  make  deductions  on  account 
of  donations  to  fairs,  churches  and  associations;  such 
donations,  although  made  for  the  purpose  of  obtaining 
and  preserving  the  good  will  of  the  farmers,  being  mere 

36  T.  D.  2090;  T.  D.  2152;  mimeograph  letter  to  collectors 
No.   1314. 

87  T.  D.  2090. 
S8T.D.  2090. 


318  FEDERAL   INCOME   TAX 

gratuities.  When  a  donation  legitimately  represents  a 
consideration  for  a  benefit  flowing,  directly  or  indirectly, 
to  the  donor,  as  an  incident  of  its  business,  it  is  an 
allowable  deduction.  Thus,  a  donation  to  a  hospital, 
under  agreement  that  employees  of  the  donor  are  to 
have  a  ward  for  their  use  in  case  of  accident  or  illness, 
is  a  proper  deduction.  Donations  made  for  purposes 
connected  with  the  operation  of  the  business,  when  lim- 
ited to  charitable  institutions,  hospitals  or  educational 
institutions,  conducted  for  the  benefit  of  employees  or 
their  dependents,  are  within  this  class.'® 

Lessees  of  Mines.  Where^  an  individual  or  a  corpo- 
ration operates  a  mine  under  a  lease  on  a  royalty  basis, 
the  lessee  "may  deduct  all  royalties  paid  to  the  owner. 
If,  in  addition  to  royalties,  the  lessee  has  paid  a  stipu- 
lated sum  for  the  right  to  explore,  develop  and  operate 
a  mine  the  amount  so  paid  may  be  ratably  distributed 
over  the  life  of  the  lease,  or  the  probable  life  of  a  mine 
under  ordinary  operating  conditions,  and  the  lessee  may 
deduct  annually  as  a  rental  payment  an  aliquot  part  of 
the  amount  of  the  bonus  so  paid,  until  such  amount 
has  been  extinguished.  If  the  annual  deduction  of  the 
bonus  is  based  on  the  probable  life  of  the  mine,  under 
ordinary  operating  conditions,  it  seems  that  the  lessee 
may  compute  the  annual  deductions  of  the  bonus  pay- 
ment on  the  same  basis  as  the  owner  computes  depletion.** 

Farmers.  A  farmer  is  permitted  to  deduct  all  legiti- 
mate expenses  incident  to  the  production  of  the  year, 
or  future  years,  although  the  products  to  which  such 
expenses  and  deductions  are  incidental  may  not  have. 

39T.D.  2090. 

40  T.  D.  2446.     See  C^hapters  33  and  34  on  depletion. 


DEDUCTION   OF   BUSINESS  EXPENSES  'J19 

been  sold.*^  For  example,  the  cost  of  a  supply  of  fer- 
tilizer sufficient  to  last  for  several  years  may  be  deducted 
in  full  in  the  year  in  which  purchased.  A  farmer  may 
deduct  as  business  expense  the  cost  of  ordinary  tools, 
but  not  the  cost  of  farm  machinery  of  a  more  perma- 
nent character.  Such  farm  machinery,  however,  is  sub- 
ject to  depreciation  as  is  other  property  subject  to  wear 
and  tear. 

Public  Utility  Under  Contract  with  a  State.    In  the 

«asc  of  a  pul)lie  utility  constructed,  operated  or  main- 
I allied  under  any  contract  with  any  city,  state  or  ter- 
ritory or  the  District  of  Columbia,  where  a  portion  of 
the  net  earnings  of  such  public  utility  is  payable,  under 
the  contract,  to  the  state,  territory,  etc.,  the  amount 
so  paid  may  be  deducted  by  the  public  utility  operating 
under  such  contract  as  an  expense  of  its  business.** 
This  deduction  is  allowed  under  an  express  provision 
of  the  statute.*^ 

41  T.  D,  2153.  A  diflFerent  rule  seems  to  be  applied  in  the  case 
i>f  nmniifacturers  where  it  has  been  held  that  the  cost  of  materials 
and  supplies  should  be  includetl  only  to  the  extent  that  the  ma- 
terials and  supplies  are  actually  used  in  the  operations  for  the 
voar.    Reg.  33,  Art.  123. 

42  T.  D.  2090. 

43  Act  of  September  8,  1916,  5  H  (b). 


CHAPTER  29 

DEDUCTION  OF  INTEREST 

The  law  provides  in  the  ease  of  citizens  and  residents 
that  all  interest  paid  within  the  year  may  be  deducted. 
In  the  ease  of  a  non-resident  alien  there  may  be  deducted 
such  proportion  of  all  interest  paid  within  the  year  by 
such  person  on  his  indebtedness  as  the  gross  amount  of 
his  income  'for  the  year  derived  from  sources  within  the 
United  States,  bears  to  the  gross  amount  of  his  income 
for  the  year  derived  from  all  sources  within  and  without 
tl^e  United  States,  but  this  deduction  is  allowed  only  if 
such  person  includes  in  his  return  of  annual  net  income 
all  the  information  necessary  for  its  calculation.  In  the 
case  of  a  corporation  there  may  be  deducted  the  amount 
of  interest  paid  within  the  year  on  its  indebtedness  to  an 
amount  of  such  indebtedness  not  in  excess  of  the  sum  of 
(a)  the  entire  amount  of  the  paid-up  capital  stock  out- 
standing at  the  close  of  the  year,  or,  if  no  capital  stock, 
the  entire  amount  of  capital  employed  in  business  at  the 
close  of  the  year,  plus  (b)  one  half  of  its  interest-bearing 
indebtedness  then  outstanding.  It  is  further  provided, 
as  to  corporations,  that  in  case  of  indebtedness  wholly 
secured  by  property  collateral  tangible  or  intangible,  the 
subject  of  sale  or  hypothecation  in  the  ordinary  business 
of  such  corporation,  as  a  dealer  only,  in  the  property 
constituting  such  collateral,  or  in  loaning  funds  thereby 
procured,  the  total  interest  paid  by  such  corporation 
within  the  year  on  any  such  indebtedness  may  be  de- 

320 


DEDUCTION  OP   INTEREST  321 

ducted  as  a  part  of  its  expense  of  doing  business,  but  in- 
terest on  such  indebtedness  shall  only  be  deducted  to  an 
amount  of  such  indebtedness  not  in  excess  of  the  actual 
value  of  such  property  collateral.  In  the  case  of  a  bank, 
banking  association,  loan  or  trust  company,  interest  paid 
within  the  year  on  deposits  or  on  moneys  received  for 
investment  and  secured  by  interest-bearing  certificates 
of  indebtedness  issued  by  such  bank,  banking  association, 
loan  or  trust  company,  may  be  deducted  in  full.  Foreign 
corporations  are  allowed  to  deduct  the  amount  of  in- 
terest paid  within  the  year  under  the  same  limitation  as 
imposed  on  domestic  corporations  and  in  such  proportion 
as  the  gross  amount  of  income  for  the  year  from  business 
transacted  and  capital  invested  within  the  United  States 
bears  to  the  gross  amount  of  income  derived  from  all 
sources  within  and  without  the  United  States.  The 
privilege  of  deducting  the  total  amount  of  interest  paid 
on  indebtedness  secured  by  property  collateral  is  not 
allowed  to  foreign  corporations,  but  the  privilege  of  de- 
ducting all  of  the  interest  paid  by  a  bank,  banking  as- 
sociation, loan  or  trust  company,  is  extended  to  foreign 
corporations  or  the  branches  thereof  to  the  extent  that 
the  interest  is  paid  on  deposits  by  or  on  moneys  received 
for  investment  from  either  citizens  or  residents  of  the 
United  States.  The  special  rules  applicable  to  each  of 
the  four  classes  of  taxpayers  enumerated  above  are  dis- 
cussed in  the  chapters  relating  to  each.*  In  all  cases  in- 
debtedness incurred  for  the  purchase  of  obligations  or 
x'curities,  the  interest  upon  which  is  exempt,  may  not  be 
deducted. 

1  As  to  citizens  and  residents  see  Chapter  4;  as  to  non-resident 
aliens  see  Chapter  5;  as  to  domestic  corporations  see  Chapter 
12;  as  to  foreign  corporations  see  Chapter  14. 

F.  I.  Tax.— 21 


322  FEDERAL   INCOME   TAX 

Indebtedness  Incurred  for  the  Purchase  of  Tax  Ex- 
empt Securities.  Prior  to  the  amendment  of  October 
'i,  1917,  it  was  held  under  the  1916  Law  that  interest 
paid  on  indebtedness  could  be  deducted  regardless  of 
whether  or  not  the  indebtedness  was  incurred  for  the 
purchase  of  bonds,  the  interest  upon  which  was  exempt 
from  taxation.  This  ruling  in  effect  permitted  a  double 
deduction,  that  is,  the  interest  paid  on  the  money  so 
borrowed  could  be  deducted  and  the  income  derived  from 
the  money  so  borrowed  and  invested  could  also  be  de- 
ducted. The  1917  Law  does  not  permit  the  deduction  of 
interest  paid  on  indebtedness  incurred  for  the  purchase 
of  obligations  or  securities  the  interest  upon  which  is 
exempt  from  taxation  as  income  under  that  law.  The 
phrase  "obligations  or  securities"  means  only  such 
securities  as  bear  interest  which  is  exempt  from  the  in- 
come tax.  State  and  municipal  bonds  are  securities 
which  would  fall  into  this  class.  National  bonds  issued 
prior  to  September  1,  1917,  would  also  fall  into  this  class. 
But  the  limitation  applies  only  where  the  interest  on  the 
securities  so  purchased  is  wholly  exempt.  Interest  on 
indebtedness  incurred  for  the  purchase  of  Liberty  Bonds 
■of  the  second  issue  (the  interest  on  which  is  not  exempt 
from  the  supertax)  may  be  deducted  regardless  of  this 
limitation. 1" 

Interest  Paid  Within  the  Year.  The  1909  Law  pro- 
vided for  the  deduction  of  "interest  actually  paid  with- 
in the  year"  and  it  was  contended  by  the  Treasury  De- 
partment that  this  provision  required  that  the  interest 
should  be  both  accrued  and  paid  within  the  same  year. 
It  was  held  by  the  Circuit  Court  of  Appeals,  however, 
that  interest  actually  paid  within  the  year  although  pre- 

UT.  D.  2541. 


J 


DEDUCTION    OK    INTERES'J"  323 

viously  accruing  should  be  permitted  as  a  deduction.* 
The  1913  Law  provided  for  the  deduction  of  interest 
paid  within  the  year  by  individuals,  and  "interest  ac- 
crued and  paid  within  the  year"  by  corporations.  In  a 
ruling  appearing  under  that  law  it  was  held  that  in  the 
case  of  cori>orations  the  deduction  should  be  limited  to 
interest  which  had  both  accrued  and  been  paid  within 
the  same  year.*  The  present  law  permits  the  deduction 
of  interest  paid  within  the  year  in  all  cases  and  it  does 
hot  seem  essential  that  the  interest  should  have  accrued 
or  become  payable  in  the  year  in  which  it  is  paid. 

Interest  paid  by  Corporations.  The  limitations  on 
the  amount  of  interest  which  may  be  deducted  by  cor- 
porations is  referred  to  in  the  chapters  on  corporations 
and  foreign  corporations  respectively. 

Interest  Paid  by  Banks.  Interest  paid  by  banks, 
banking  associations,  loan  or  trust  companies  on  deposits 
may  be  deducted  in  full.  For  a  discussion  of  the  rulings 
on  this  point  see  the  chapters  on  corporations  and  foreign 
corporations  respectively. 

8  Anderson  v.  42  Broadway  CJompany,  21.'{  Fed.  777.  The 
Sujireme  Court  in  reversing  the  conrt  on  anotiter  point  <l'u\  not 
pass  on  the  question  of  deducting  interest  accrued  in  one  year 
and  paid  in  another. 

8  T.  D.  1960. 


CHAPTER  30 

DEDUCTION   OF    TAXES 

In  the  case  of  individuals  and  domestic  corporations 
the  provisions  for  the  deduction  of  taxes  are  the  same. 
In  the  case  of  non-resident  aliens  and  foreign  corpora- 
tions the  taxes  which  may  be  deducted  are  limited  to 
those  assessed  by  the  Uilited  States  or  its  teritories  or 
possessions  or  under  the  authority  of  any  state,  county, 
school  district  or  municipality  or  other  taxing  subdivision 
of  any  state,  paid  within  the  United  States,  within  the 
year,  except  such  taxes  as  are  not  deductible  by  any  class 
of  taxpayers.  For  the  special  rulings  applicable  to  non- 
resident aliens  and  foreign  corporations  see  the  respec- 
tive chapters  on  those  subjects. 

Taxes  Paid  Within  the  Year.  Under  the  1913  Law 
and  the  1916  Law  the  provisions  for  deducting  taxes 
expressly  limited  deductions  to  taxes  paid  within  the 
year.  It  was  held  by  the  Treasury  Department  that  re- 
serves for  taxes  could  not  be  established  as  only  such  sums 
as  were  actually  paid  within  the  year  could  be  deducted, 
that  is,  the  aggregate  of  the  amounts  actually  paid  as 
shown  by  the  cash  book.^  The  provision  of  the  1916  Law 
allowing  individuals  and  corporations  to  report  on  a 
basis  other  than  that  of  actual  receipts  and  disburse- 
ments, and  the  rulings  by  the  Treasury  Department  there- 

1  Eeg.  33,  Arts.  156,  158. 

324 


DEDUCTION    OF   TiVXES  325 

under,  would  seem  to  permit,  in  the  ease  of  individuals 
or  corporations  reporting  on  an  accrual  basis,  the  de- 
duction of  the  amount  of  taxes  accrued  on  their  books 
or  the  amounts  reserved  for  the  payment  of  taxes  pro- 
viding such  amounts  did  not  exceed  the  actual  liability 
incurred  during  the  year.* 

Ta,xes  Not  Deductible.  The  law  expressly  provides 
that  the  taxpayer  shall  not  deduct  the  amount  of  income 
taxes  paid  within  the  year  under  the  1916  or  1917  Laws 
and  the  amount  of  excess  profits  taxes  paid  to  the  Federal 
Government.*  It  is  provided,  however,  that  in  assessing 
the  tax  for  any  year  the  Commissioner  of  Internal 
Revenue  shall  deduct  the  amount  of  the  exceSs  profits 
tax  assessed  for  the  year  from  the  net  income  of  that 
year  before  assessing  the  income  tax.*  The  Act  also  pro- 
vides that  taxes  assessed  against  local  benefits  shall  not 
be  deductible  and  that  taxes  paid  by  a  corporation  pur- 
suant to  a  '* tax-free"  contract  in  its  mortgages  or  bonds, 
shall  not  be  deducted.  In  addition  the  Treasury  De- 
partment holds  that  inheritance  taxes  are  not  deductible 
and  taxes  paid  by  a  corporation  for  its  stockholders  have 
been  held  by  the  courts  to  be  not  deductible. 

Income  and  Excess  Profits  T.vxes.  Prior  to  the 
amendment  of  October  3,  1917,  it  was  held  that  the  in- 
come tax  paid  on  income  of  one  year,  whether  paid  by 
the  taxpayer  or  withheld  at  the  source  by  the  withholding 
agent,  was  properly  deductible  from  the  net  income  of 

«T.  D.  2433. 

»Act  of  September  8,  1916,  8fi  5,  6,  12  (a)  and  12  (b),  as 
amended  by  Act  of  October  3,  1917. 

*  Act  of  September  8,  1916,  S  29,  added  by  Act  of  October  3, 
1917. 


326  FEDERAL   INCOME  TAX 

the  following  year.^  The  1917  Amendment  however, 
expressly  provides  that  the  Federal  income  taxes  and  the 
Federal  excess  profits  taxes  shall  not  be  allowed  as  a 
deduction.  Income  taxes,  or  other  taxes,  levied  by  any 
state  or  government,  other  than  the  Federal  Government, 
are  proper  deductions.  In  assessing  the  income  tax, 
however,  the  net  income  embraced  in  the  return  is 
credited  by  the  Commissioner  t)f  Internal  Revenue  with 
the  amount  of  any  excess  profits  tax  imposed  by  Act  of 
Congress  and  assessed  for  the  same  calendar  or  fiscal 
year  upon  the  taxpayer,  and,  in  the  case  of  a  member  of 
a  partnership,  with  his  proportionate  share  of  such 
excess  profits  tax  imposed  upon  the  partnership.^ 

Taxes  Assessed  Against  Local  Benefits.  Taxes  paid 
pursuant  to  assessments  levied  by  special  districts,  such 
as  irrigation,  reclamation,  and  drainage  districts,  for 
sidewalks  in  cities,  street  extension,  grading,  paving, 
etc.,  are  held  to  be  taxes  assessed  against  local  benefits 
and  not  allowed  as  deductions.''  The  taxes  contemplated 
by  the  law  as  deductible  are  those  w^hich  are  paid  to 
defray  the  expense  of  running  the  government.  Where 
the  taxpayer  pays  an  assessment  for  something  which 
will  directly  benefit  him  or  his  property  it  is  not  con- 
sidered to  be  a  tax  in  the  true  sense  but  rather  in  the 
nature  of  an  investment  in  property. 

Taxes  Pmd  Under  "Tax-Free^'  Covenants.  Where 
a  corporation  pays  taxes  for  its  bondholders  under  stipu- 
lations in  bonds  agreeing  to  pay  the  interest  in  full,  re- 

5  T.  D.  2135. 

8  Act  of  September  8,  1916,  §  29,  added  by  Act  of  October  3. 
1917. 

tT.  D.  2090;  Reg.  33,  Art.  153. 


DEDUCTION   OP  TAXES  327 

gardless  of  any  tax  which  it  may  be  required  to  withhold 
or  deduct,  the  amount  of  taxes  so  paid  on  behalf  of  sueli 
bondholders  is  not  a  proper  deduction  by  the  corpora- 
tion.* The  rulings  on  this  point  are  contained  in  the 
chapter  on  corporations.  The  bondholder  may,  however, 
treat  the  amount  so  paid  for  him  as  his  tax  and  deduct 
the  same,  if  it  is  a  tax  levied  by  a  state ;  if  levied  by  the 
federal  government  he  cannot  deduct  the  amount  as  the 
law  expressly  prohibits  deduction  of  the  federal  income 
tax.  On  the  other  hand,  the  bondholder  should  report  as 
additional  income  the  amount  of  tax  so  paid  for  him  by 
the  corporation. 

Inheritance  Taxes.  A  collateral  inheritance  tax,  such 
as  that  levied  under  the  laws  of  the  State  of  New  York, 
being  a  charge  against  the  corpus  of  the  estate  is  not 
considered  ta  be  such  a  tax  as  is  allowed  to  be  deducted 
under  this  provision  of  the  law,  either  in  computing  the 
net  income  of  the  estate  or  the  net  income  of  the  bene- 
ficiary.® Whether  or  not  under  any  conditions  an  in- 
heritance tax  may  be  deducted  has  not  been  decided, 
hut  it  seems  that  the  theory  adopted  by  the  Treasury 
Department  is  that  an  inheritance  tax  is  not  in  a  true 
sense  a  tax  which  operates  to  reduce  the  income  of  the 
taxpayer  for  the  year,  and  is  rather  the  taking  of  a 
part  of  the  corpus  of  the  estate. 

Taxes  Paid  by  Corporation  for  Stockholders.  Under 
the  statutes  of  many  of  the  states  taxes  are  assessed 
against  the  stockholders  of  banks,  the  bank  being  re- 
quired to  pay  the  tax  on  behalf  of  its  stockholders.     In 

»  T.  D.  1948. 

» Letter  from  Treasury  Department  dated  February  10,  1916; 
I.  T.  S.  1917.  «It3.')2  and  661. 


328  FEDEBAL  IXCOMB  TAX 

such  cases  it  was  held,  under  the  1909  Law,  that  the 
bank  was  not  entitled  to  deduct  the  amount  of  taxes 
so  paid  as  the  tax  was  not  a  tax  upon  the  bank  or  upon 
its  property.^®  This  rule  was  continued  under  the  1913 
Law  and  the  present  laws,  such  taxes  being  held  to  be 
against  the  property  of  the  private  stockholders  and  not 
against  either  the  corporation  or  its  property.^^  The 
requirements  of  a  state  law  that  a  bank  shall  pay  for 
the  stockholder  cannot  be  construed  as  authority  under 
which  the  bank  may  deduct  the  tax.^^  Where  a  statute 
requires  the  bank  to  pay  the  tax  and  gives  it  a  lien  upon 
the  shares,  the  bank  is  not  entitled  to  deduct  the  tax.^* 
Where  the  statute  gives  the  bank  the  option  either  to 
pay  the  tax  out  of  its  general  funds  or  to  collect  the  same 
from  its  stockholders,  that  fact  does  not  change  the  char- 
acter of  the  tax  as  a  tax  against  the  property  of  the  indi- 
vidual stockholders,  and  the  bank  cannot  deduct.^*  Even 
though  the  state  statute  makes  no  provision  for  recovery 
from  the  several  shareholders  of  their  proportional  part 
of  the  amount  so  paid,  the  bank  cannot  deduct.^^  The 
absence  of  an  express  provision  in  the  statute  does  not 
show  that  there  is  no  such  right  of  recovery,  or  that  the 
intention  was  for  the  tax  to  fall  ultimately  upon  the  bank 
and  not  upon  the  stockholders.^^    As  a  general  rule  the 

10  T.  D.  1763. 

H  The  Northern  Trust  Company  v.  McCoach,  215  Fed.  991 ; 
T.  D.  2135. 

12  T.  D.  2161. 

13  Eliot  National  Bank  v.  Gill,  210  Fed.  833;  aff'd  218  Fed. 
600;  National  Bank  of  Commerce  v.  Allen,  211  Fed.  743;  aff'd 
223  Fed.  472;  petition  to  the  United  States  Supreme  Court  for 
writ  of  certiorari  denied  October  25,  1915. 

14  Northern  Trust  Company  v.  McCoach,  215  Fed.  991. 

16  First  Nat.  Bank  of  Jackson,  Miss.  v.  McNeel,  238  Fed.  559. 
16  Home  Savings  Bank  v.  DesMoines,  205  U.  S.  503. 


DEDUCTION   OP  TAXES  329 

amounts  of  taxes  so  paid  by  a  corporation  for  its  stock- 
holders are  not  collected  from  the  stockholders,  the  cor- 
poration charging  the  taxes  as  an  item  of  expense.  Such 
taxes,  however,  should  be  reported  by  the  stockholders 
respectively  as  taxes  paid  by  them,  according  to  their 
proportionate  interests  in  the  corporation.^"'  The  amount 
of  the  taxes  so  paid  should  also  be  treated  as  additional 
income  from  the  net  earnings  of  the  corporation.^' 
Where  shares  of  stock  are  sold  after  the  tax  has  been 
assessed,  but  prior  to  the  time  it  is  paid  by  the  corpora- 
tion on  behalf  of  the  stockholders,  the  one  holding  the 
stock  on  the  date  when  a  tax' became  due  and  payable 
is  the  one  entitled  to  report  the  amount  as  a  dividend 
and  deduct  the  amount  as  a  tax  paid  by  him.^* 

• 
Bank  Guaranty  Fund.  Banking  corporations  which, 
pursuant  to  the  laws  of  the  state  in  which  they  are  doing 
business,  are  required  to  set  apart  an  amount,  levied 
and  assessed  against  them  by  the  state  authorities,  as  a 
"depositor's  guaranty  fund"  may  deduct  the  same  from 
their  gross  income,  provided  the  fund  is  set  aside  and 
carried  to  the  credit  of  the  state  banking  board  or  other 
duly  authorized  state  officer,  and  may  be  withdrawn 
upon  demand  by  such  board  or  state  officer  to  meet  the 
demands  of  these  officials  in  reimbursing  depositors  of 
insolvent  banks,  and,  provided  further,  that  no  portion 
of  the  amount  so  set  aside  and  credited  is  returnable, 

"T.  D.  2135. 

"See  Chapter  2.3. 

19  Letter  from  Treasury  Department  dated  February  25,  1916; 
I.  T.  S.  1917,  11357.  An  earlier  ruling  in  a  letter  dated  March 
-,  1915,  held  that  the  stockholder  owning  the  stock  at  the  time 
the  taxes  were  assessed  was  the  one  entitled  to  the  deduction,  but 
the  later  ruling  referred  to  above  seems  to  indicate  the  present 
attitude  of  the  Treasury  J)epartmcnt, 


330  FEDERAL   INCOME  TAX 

under  the  existing  laws  of  the  state,  to  the  assets  of  the 
banking  corporation.  In  such  cases  the  amount  of  the 
guaranty  fund  is  no  longer  an  asset  of  the  bank,  but 
is  in  the  nature  of  a  tax  and  as  such  is  deductible.^® 
Strictly  speaking,  such  assessments  are  more  proper!}^ 
deductible  as  an  expense  of  doing  business  or,  perhaps, 
as  a  loss,  since  the  fund  is  intended  to  meet  the  losses  of 
the  banking  business  as  a  whole. 

Taxes  Paid  by  a  Tenant.  Where  a  tenant  pays  the 
taxes  on  property  leased  by  him,  he  may  consider  the 
amount  so  paid  as  an  additional  payment  of  rent  and 
may  deduct  it  as  an  expense  of  carrying  on  his  busi- 
ness.''^ To  the  landlord  the  amount  is  equivalent  to  an 
additional  payment  of  rent  •  and  must  be  reported  as 
such,  but  he  may  also  deduct  the  amount,  as,  to  him, 
it  is  a  tax  paid  during  the  year  by  the  tenant  as  his 
agent.  The  transaction  is  tantamount  to  a  payment  of 
the  sum  by  the  tenant  to  the  landlord  and  a  repayment 
by  the  landlord  to  the  tenant,  as  his  agent,  for  the  pur- 
pose of  satisfying  the  tax. 

20  T.  D.  2152. 

21  T.  D.  2090.  ' 


I 


CHAl^TER  31 
% 

DEDUCTION  OP  LOSSES 

The  law  provides  in  the  ease  of  individuals  that ' '  losses 
actually  sustained  during  the  year,  incurred  in  business 
or  trade,  or  arising  from  fires,  storms,  shipwreck  or 
other  casualty,  and  from  theft,  when  such  losses  are  not 
compensated  for  by  insurance  or  otherwise,  may  be 
deducted,  as  also  may  debts  due  the  taxpayer  actually 
ascertained  to  be  worthless  and  charged  off  within  the 
year.  In  the  case  of  the  individual  there  is  a  limitation 
as  to  the  amount  of  loss  which  may  be  deducted  in  trans- 
actions entered  into  for  profit  but  not  connected  with  his 
business  or  trade.  This  limitation  and  a  discussion  of 
losses  incurred  in  trade  is  contained  in  the  chapter  on 
citizens  and  residents.*  The  rules  discussed  in  this  chap- 
ter are  those  applicable  to  corporations  and  individuals  • 
generally.  In  the  case  of  corporations  all  losses  actually 
sustained  and  charged  off  within  the  year  and  not  com- 
pensated by  insurance  or  otherwise  may  be  deducted.* 

Measure  of  Loss.  In  the  case  of  loss  of  property  or 
assets  the  loss  must  be  based  upon  the  difference  between 
the  cost  value  and  the  salvage  value  of  the  property  or 
assets,  including  in  the  latter  value  such  amount,  if  any, 
as  has,  in  the  current  or  previous  years,  been  set  aside 

1  See  Chapter  4. 

9  Act  of  September  8,  1916,  §  12  (a). 

.331 


332  FEDERAL   INCOME   TAX 

and  deducted  from  gross  income  by  way  of  depreciation.^ 
When  property  is  sold,  the  loss  is  the  difference  between 
the  selling  price  and  cost  where  the  selling  price  is  less 
than  the  cost.*  In  a  case  arising  under  the  1909  Law, 
the  court  said :  ' '  There  seems  to  be  no  limitation  pro- 
vided in  the  act  as  to  the  amount  of  deductions  to  be 
allowed  for  losses  actually  sustained  from  any  source 
during  the  year,  and  whether  due  to  conditions  of  busi- 
ness, the  sale  of  property,  or  anything  else,  and  the  court 
must,  therefore,  assume  that  the  statute  contemplated 
that  the  full  amount  of  all  losses  sustained  within  the 
year  would  be  allowed. ' '  ^ 

Losses  Must  Be  Actually  Sustained  During  Year. 

The  law  provides  in  the  ease  of  individuals  that  the  loss 
must  be '  *  actually  sustained  during  the  year ' '  and  in  the 
case  of  corporations  that  the  loss  must  be  "actually  sus- 
tained and  charged  off  within  the  year. ' '  The  Treasury 
Department  holds  that  a  loss  to  he  deductible  must  be 
an  absolute  loss,  actually  sustained  and  ascertained  dur- 
ing the  tax  year  for  which  the  deduction  is  sought  to  be 
made.  It  must  be  incurred  in  trade  and  be  determined 
and  ascertained  upon  an  actual,  a  completed,  a  closed 
transaction.  Losses  sustained  from  the  sale  or  dealings 
in  personal  or  real  property  growing  out  of  the  owner- 

8  Beg.  33,  Art.  124. 

4T.  D.  2090. 

6  Connecticut  Mutual  Life  Ins.  Co.  v.  Eaton,  218  Ted.  206. 
In  this  case  the  court  required  the  corporation  to  report  as  income 
all  of  its  profits  and  permitted  it  to  deduct  all  of  its  losses  on 
the  sale  of  property  during  the  year,  regardless  of  the  fact  that 
some  of  the  property  was  purchased  prior  to  the  incidence  of  the 
tax,  it  appearing  that  the  result  would  be  the  same  if  the  gains 
and  losses  had  been  pro-rated  as  then  required  by  the  Treasury 
Department. 


DEDUCTION  OP  LOSSES  333 

ship  or  use  of,  or  interest  in,  such  property  will  not  be 
deductible  at  all  unless  they  are  ascertained,  determined 
and  fixed  as  absolute  in  the  above  sense  within  the  tax- 
able year  in  which  the  deduction  is  sought  to  be  made.® 
The  amount  to  be  deducted  as  a  loss  should  have  in  it  no 
element  of  "depreciation"  or  "allowance  for  wear  or 
tear"  or  "compensation  from  insurance  or  otherwise." 
The  amount  is  to  be  an  absolute  and  complete  loss  which 
has  been  actually  sustained^ 

Must  Be  Charged  Off  on  the  Books.  In  the  case  of 
corporations  the  loss  may  not  be  deducted  unless  it  is 
actually  sustained  during  the  year  and  charged  off  on 
the  books.*  This  rule  would  seem  to  apply  with  equal 
force  in  the  case  of  an  individual  who  keeps  books,  but 
one  who  does  not  keep  books  is  not  thereby  deprived  by 
the  law  of  the  right  to  claim  a  loss,  except  in  the  case  of 
worthless  debts. 

Fluctuations  in  Book  Values.  Fluctuations  during 
the  year  in  the  value  of  capital  assets,  such  as  securities, 
for  instance,  even  though  evidenced  by  book  entries  do 
not  constitute  losses  actually  sustained.  A  loss  may  not 
be  deducted  until  as  a  result  of  a  completed,  a  closed 
transaction,  the  loss  has  been  definitely  ascertained  and 
the  amount  it  represents  has  irredeemably  disappeared 
from  the  assets  of  the  taxpayer.* 

Reserves  for  Losses.  Reserves  to  take  care  of  an- 
ticipated or  probable  losses  are  not  a  proper  deduction.*® 

6T.  D.  2005. 
7  T.  D.  2005. 

»  Reg.  33,  Arts.  124  and  158. 

•  Letter   from    Treasury   Department   dated   August   14,   1914; 
I.  T.  S.  1917,  H  259. 
10  Reg.  33,  Art.  126. 


334  FEDERAL   INCOME   TAX 

On  the  other  hand,  loss  actually  sustained  during  the 
year  may  be  deducted  although  it  is  made  good  out  of 
a  fund  which  has  been  accumulated  as  an  insurance 
reserve  by  the  taxpayer.^^ 

Loss  of  Capital.  What  the  law  contemplates  as  a 
deduction  is  the  loss  of  capital,  either  by  the  sale  of 
property  or  by  the  destruction  or  disappearance  of  prop- 
erty. It  is,  therefore,  immaterial  in  what  year  the  capi- 
tal was  created  so  long  as  the  loss  is  actually  sustained 
in  the  taxable  year.  It  does  not  seem  that  the  loss  need 
necessarily  be  one  connected  with  the  business  or  trade 
of  an  individual,  except  in  the  case  of  losses  resulting 
from  sales  or  dealings  in  property,  in  which  case  the 
law  expressly  provides  as  to  individuals  that  the  loss 
must  be  incurred  in  his  trade  or  business.  Losses  re- 
sulting from  the  destruction  or  loss  of  property  by  fire, 
storm  or  other  casualty,  or  theft,  seem  to  be  deductible 
under  the  present  language  of  the  law  whether  or  not 
the  property  is  used  in  the  taxpayer's  business  or  trade.^'* 

Losses  of  Income.  Loss  of  income  is  not,  generally 
speaking,  a  proper  deduction.  If,  for  instance,  a  debtor 
defaults  in  payment  of  interest,  or  a  corporation  fails  to 
pay  a  regular  dividend,  or  an  employer  fails  to  pay 
commissions  or  salaries,  the  amount  of  such  items  may 
not  be  deducted  from  other  income  during  the  year,  as 
the  income  is  reduced  by  the  mere  fact  that  the  such 
sums  are  not  included.  If,  however,  the  taxpayer  has 
reported  any  such  amounts  as  income  for  the  taxable 
year,  or  a  preceding  year,  as  might  be  done  in  the  case 

llEeg.  33,  Art.  122. 

12  See  Act  of  September  8,  1916,  §5  (a),  language  of  fourtli 
deduction;   also  §6  (a),  language  of  fourth  deduction. 


DEDUCTION   OF   LOSSES  335 

of  taxpayers  reporting  on  a  basis  other  than  that  of 
actual  receipts  and  disbursements,  the  subsequent  failure 
to  collect  the  amounts  so  entered  on  the  books  may  be 
treated  as  a  loss  when  it  is  determined  that  the  amount 
is  not  collectible.  For  a  further  discussion  of  this  point 
see  the  paragraph  l>elow  on  worthless  debts. 

Losses  in  Business  Transactions.  The  most  frequent 
deductions  for  losses  are  claimed  as  a  result  of  the  sale 
of  property.  In  such  cases  the  loss  occurs  when  the 
selling  price  is  less  than  the  cost.  This  is  the  converse 
of  gain  from  the  sale  of  property  which  is  discussed  in 
a  preceding  chapter.*'  The  cost  of  the  property  is 
determined  in  the  same  manner  whether  the  transaction 
results  in  a  loss  or  a  gain  and  the  same  rules  apply  with 
respect  to  property  acquired  prior  to  March  1,  1913. 

Sale  of  Capital  Stock.  Wher£  the  capital  stock  of  a 
corporation  is  issued  for  less  than  par,  the  amount  of 
discount  is  not  an  allowable  deduction  to  the  corporation. 
Such  a  transaction  is  purely  a  capital  transaction  and 
the  income  of  the  corporation  is  not  directly  decreased 
by  reason  of  the  sale  of  the  stock  at  a  price  less  than  its 
par  value.** 

Exchange  of  Stock.  Where  in  a  case  of  merger 
stockholders  of  one  corporation  exchange  their  stock  for 
stock  of  the  corporation  resulting  from  the  merger  and 
receive  a  par  value  less  than  the  par  value  of  the  old 
stock,  it  is  held  that  the  transaction  constitutes  a  sale 
for  income  tax  purposes,  and  that  a  deduction  may  be 
I'laimed  for  any  loss  measured  by  the  difference*  between 

IS  See  Chapter  20. 
14  T.  D.  2090. 


336  FEDERAL   INCOME   TAX 

the  value  of  the  old  stock  on  March  1,  1913,  (jor  the  cost, 
if  purchased  subsequent  to  that  date)  and  the  value 
at  which  the  same  stock  was  given  in  exchange  for  stock 
of  the  company  resulting  from  the  merger.  If  the  stock 
of  the  new  corporation  has  a  market  value  at  or  about 
the  time  of  the  merger,  it  has  been  indicated  that  the 
Treasury  Department  will  hold  the  market  value  to  be 
equivalent  of  cash  in  determining  the  selling  price. 
Such  losses  of  course,  may  be  deducted,  in  the  case  of 
individuals,  only  to  the  extent  that  they  do  not  exceed 
gains  from  other  similar  transactions  during  the  year.^^ 

Amounts  Paid  to  Make  Up  Profits  of  Another  Under 
Agreement.  Contracts  guaranteeing  the  payment  of 
dividends  or  interest  of  one  corporation  by  another  are 
frequently  made  between  corporations  having  close  busi- 
ness relations.  Whether  or  not  amounts  paid  under 
such  contracts  or  guarantees  may  be  deducted,  as  a  loss 
or  as  an  expense  of  doing  business,  by  the  paying  cor- 
poration has  not  been  determined  by  the  courts  in  this 
country.  In  England  such  payments  have  been  held 
properly  deductible  as  sums  expended  for  the  purpose  of 
trade.^®     If  the  payment  is  made  under  an  enforceable 

16  Letter  from  Treasury  Department  dated  March  9,  1917; 
I.  T.  S.  1917,  If  2122.     See  Chapter  16. 

16  Moore  v.  Stewarts  &  Lloyds  (1906)  8  Fraser  1129.  In  this 
ease  it  was  observed  that  the  question  was  one  of  fact  rather 
than  of  law.  One  company  entered  into  agreement  with  another 
whereby  in  return  for  the  right  to  nominate  a  majority  of  directors 
of  the  second  company  the  first  undertook  to  pay  to  the  second 
such  sums  each  half  year  as  might  be  necessary  to  make  up  any 
deficit  in  the  dividends  on  the  latter 's  preferred  shares.  The 
court  said,  "If  the  agreement  was  entered  into  with  a  view  to 
profit,  as  I  think  it  was  *  *  *  then  the  annual  charge  to  the 
respondent  company  is  in  my  view  a  part  of  their  business  outlay 
or  expenditure  and  is  not  subject  to  assessment." 


DEDUCTION   OP  LOSSES  337 

contract  there  seems  to  be  no  reason  why  the  amount 
should  not  be  deducted  either  as  loss  or  expense. 

Voluntary  Payment  by  Stockholders  of  Loss  of  Cor- 
poration. Assessments  made  by  a  corporation  on  its 
capital  stock  are  regarded  as  an  investment  of  capital 
and  the  amounts  paid  do  not  constitute  allowable  deduc- 
tions to  the  stockholders,*^  This  rule  was  held  to  apply 
in  a  case  where  a  corporation  showed  a  deficit  at  the 
close  of  the  year  and  the  stockholders  agreed  to  make 
it  good  by  the  payment  of  voluntary  contributions.** 

Issue  of  Bonds  Below  Par.  Where  bonds  are  issued 
for  a  price  less  than  par  and  are  redeemable  at  par,  the 
Treasury  Department  has  held  that  the  loss,  which  must 
eventually  be  sustained  on  redemption  of  the  bonds,  may 
l)e  deducted  by  pro-rating  the  amount  of  the  discount  in 
accordance  with  the  life  of  the  bond.*®  The  intention 
of  this  ruling  is  to  allow  corporations  selling  their  own 
bonds  at  a  discount  to  pro-rate  the  discount  over  the  life 
of  the  bonds  and  to  deduct  from  gross  income  each  year 
an  aliquot  part  of  the  discount,  determined  in  accordance 
with  the  number  of  years  which  the  bonds  have  to  run 
from  the"  date  of  issue.  If,  however,  the  bonds  were 
issued  prior  to  the  incidence  of  the  tax  and,  at  that  time, 
the  entire  amount  of  the  discount  was  charged  to  profit 
and  loss,  the  issuing  corporation  may  not  claim  a  pro- 
rata allowance  for  such  discount  for  the  years  subsequent 
to  the  incidence  of  the  tax.*®    Charging  off  the  discount 

17  T.  D.  2090. 

1*  Letter  from  Treasury  Department  dated  February  21,  1916; 
I.  T.  S.  1917,  f  340. 
"Reg.  33,  Art  135. 
WT.  D.  2161. 
F.  I.  Tax.— 22 


338  FEDERAL   INCOME  TAX 

prior  to  the  incidence  of  the  tax  constitutes  a  closed 
transaction  and  such  transaction  cannot  be  re-opened  for 
the  purpose  of  reducing  the  taxable  income  of  the  cor- 
poration^i  The  court  has  held  that  if  a  loss  sustained  by 
a  corporation  selling  its  own  bonds  at  a  discount  is  an 
expense,  it  will  not  be  paid  until  the  maturity  of  the 
bonds  and  should,  therefore,  be  pro-rated  over  the  life 
of  the  bonds,  and  not  deducted  in  full  in  the  year  in 
which  the  bonds  were  issued.^ 

Purchase  of  Bonds  for  Retirement.  Where  bonds  have 
been  issued  at  par,  under  the  terms  of  an  indenture  re- 
quiring the  corporation  annually  to  purchase  and  retire 
a  certain  number  of  the  bonds,  and  the  corporation  is 
required  to  purchase  such  bonds  for  retirement  in  the 
market,  the  difference  between  par  value  of  the  bonds 
and  the  amount  paid  for  the  bonds  on  retirement  is 
deductible  as  a  loss.  If  the  bonds  were  issued  at  a 
premium,  the  loss  to  be  claimed  should  be  the  difference 
between  the  price  at  which  the  bonds  were  issued 
and  the  price  at  which  they  were  purchased  for  retire- 
ment, unless  the  amount  of  premium  received  on  the 
original  sale  of  the  bonds  was  accounted  for  as  income 
in  the  year  in  which  the.  bonds  were  sold,  in  which  case 
the  difference  between  the  par  value  and  the  purchase 
price  may  be  deducted.  In  the  event  the  bonds  were 
issued  at  a  discount,  and  the  discount  was  charged 
against  the  earnings  of  the  year  in  which  issued,  the 
difference  between  the  par  and  the  purchase  price  may 
be  deducted  as  a  loss ;  but  if  the  discount  on  the  bonds 
was  pro-rated  over  the  life  of  the  bonds  and  the  annual 
proportion    charged    against    the    yearly    income,    tlio 

81  T.  D.  2137. 

W  Baldwin  Locomotive  Works  v.  McCoaeh,  221  Fed.  .59. 


^ 


DEDUCTION    OP  LOSSES  339 

aiuouut  to  be  charged  off,  as  a  loss,  should  be  the  differ- 
ence Ijetween  the  price  at  which  the  bonds  were  issued 
and  the  purchase  price  minus  an  allowance  for  the  sums 
that  have  been  charged  off  annually  on  account  of  the 
pro-rated  discount.*^ 

Bonds  Purchased  Above  Par.  Where  bonds  have 
lieen  purchased  above  par  it  seems,  under  the  present 
law,  that  no  deduction  can  ordinarily  be  made  for  the 
loss  of  the  amount  of  the  premium  until  the  bonds  are 
•Mther  sold  in  the  market  before  maturity,  or  until  the 
l)rincipal  sum  is  received  at  the  time  of  maturity.  In 
either  case  the  losses  will  be  the  difference  between  the 
amount  paid  and  the  amount  received.  Where,  however, 
a  taxpayer  reports  on  a  basis  other  than  of  actual  re- 
ceipts and  disbursements  it  seems  that  this  sum  may 
properly  be  deducted  in  proportionate  amounts  each  year 
as  amortization.** 
« 

Loss  by  Destruction  or  Disappearance  of  Property. 
The  law  expressly  provides,  in  the  case  of  individuals, 
that  the  loss  arising  from  fires,  storms,  shipwrecks,  or 
other  ea.sualty,  or  theft,  may  be  deducted  in  the  year  in 
which  the  loss  is  sustained.  This  kind  of  loss  is  allowed 
to  corporations  without  specific  mention,  as  with  respect 
to  corporations  all  losses  are  deductible.  In  the  case  of 
non-resident  aliens  the  law  permits  the  deduction  of  all 
^tich  losses  of  property  within  the  United  States,  and  this 

88  Letter  from  Treasury  Department  dated  March  2.*1,  }9\r>: 
I.  T.  S.  1917,  ^1326. 

*♦  Under  the  1909  Law  it  was  held  that  where  bonds  were  pur- 
•■liased  at  a  rate  above  par  a  proportionate  amount  of  the  premium 
might  be  deducted  each  year  on  aecount  of  amortization.  T.  D. 
1727. 


340  FEDERAL 'income  TAX 

is  apparently  intended  also  in  the  case  of  foreign  cor- 
porations, although  the  language  of  that  provision  seems 
to  limit  the  losses  to  business  or  trade  conducted  by  the 
foreign  corporation  within  the  United  States.^^  In  all 
cases  the  law  provides  that  the  deduction  may  be  made 
only  when  such  losses  are  not  compensated  for  by  in- 
surance or  otherwise.  The  intent  seems  to  be  to  permit 
a  deduction  of  the  losses  to  the  extent  that  the  taxpayer 
is  not  compensated  by  insurance  or  otherwise,  and  that 
if  he  is  compensated  for  part  of  such  loss  he  may  deduct 
the  part  for  which  he  is  not  so  compensated.  In  claiming 
a  loss  due  to  the  destruction  of  property  the  salvage 
value  of  the  property  must  be  considered  as  a  partial 
compensation  to  be  deducted  from  or  not  included  in  the 
amount  claimed  as  deduction.  Further,  if  depreciation 
has  been  claimed  from  time  to  time  upon  the  property 
so  destroyed,  the  aggregate  amount  of  such  depreciation 
allowance  should  be  deducted  from  the  cost  of  the  prop- 
erty in  ascertaining  the  amount  of  the  loss.  In  this,  as 
in  all  other  cases,  the  measure  of  the  loss  is  the  difference 
between  the  cost  of  the  property  and  the  amount  received 
as  compensation.  The  value  of  the  property  at  the  time 
of  the  loss  is  not  intended  to  be  the  measure  of  the  loss, 
and  it  is  not  clear  whether  or  not  the  value  on  March  1, 
1913,  may  be  taken  instead  of  the  cost,  where  the  prop- 
erty was  acquired  prior  to  that  date,  as  is  expressly  per- 
mitted by  law  in  sales  of  property.*® 

Loss  OF  Live  Stock.  Where  a  farmer  has  purchased 
live  stock  which  afterwards  dies  from  disease  or  injury, 
or  is  killed  by  order  of  government  authorities,  and  the 

26  See  Act  of  September  8,  1916;   §§5  (a),  6  (a),  12  (a)  and 
12  (b). 
26  See  Chapter  20. 


DEDUCTION   OP   LOSSES  341 

cost  thereof  has  not  been  claimed  as  an  item  of  expense,*'' 
the  actual  purchase  price  of  such  stock,  less  any  deprecia- 
tion which  may  have  previously  been  claimed,  may  be 
deducted  as  a  loss.  Any  other  property  destroyed  by 
order  of  government  authorities  may  in  a  like  manner  be 
claimed  as  a  loss;  but  if  in  any  case  reimbursement  is 
made  by  the  government  in  whole  or  in  part  on  account 
of  the  stock  killed  or  property  destroyed,  the  amount 
so  received  must  be  reported  as  income  for  the  year  in 
which  reimbursement  is  made,'**  that  is  to  say,  only  net 
loss  is  allowable  as  a  deduction. 

Shrinkage  or  Deterioration  in  Storage.  Loss  due 
to  shrinkage  or  deterioration  of  protluce  in  storage  is 
not  allowed  as  a  deduction.  Such  shrinkage  or  deteriora- 
tion is  reflected  in  the  selling  price  when  the  goods  are 
sold  and  correspondingly  reduces  the  net  income  at  that 
time.**  • 

Worthless  Stock.  A  loss  is  none  the  less  actual  be- 
cause an  individual  cannot  divest  himself  of  the  posses- 
sion of  worthless  stock  by  sale,  but  that  condition  alone 
does  not  give  the  loss  in  question  such  a  character  as 
appears  to  the  Treasury  Department  to  have  been  con- 
templated by  the  income  tax  law.'"  However,  if  the 
stock  has  even  the  slightest  value  so  that  it  may  be  sold 
for  any  amount  it  seems  the  loss  may  be  deducted  as  it 
is  then  the  result  of  a  closed  transaction.  It  seems,  also, 
that  the  loss  would  be  properly  deductible  if  the  corpora- 

97  A  farmer  may  deduct  as  an  item  of  expense  the  cost  of  live 
stock  purchased  for  re-sale. 
MT.  D.  2153. 
WT.  D.  2153. 
SOT.  D.  2135. 


342  FEDERAL   INCOME   TAX 

tion  has  been  dissolved,  or  if  its  charter  has  been  for- 
feited since  then  there  is  a  final  ascertainment  of  the 
loss. 

District  Irrigation  Bonds.  District  irrigation  bonds 
as  a  rule,  if  not  always,  are  a  lien  upon  the  real  estate 
affected  by  the  irrigation  project  and  until  the  corpora- 
tion has  taken  such  steps  as  are  necessary  to  protect  its 
rights  and  enforce  the  collection  of  the  bonds  it  does 
not  appear  that  the  corporation  would  be  warranted  in 
writing  out  of  its  assets  and  deducting  from  income,  as 
a  loss,  the  face  value  or  any  other  arbitrarily  ascertained 
amount  representing  a  loss  or  shrinkage  in  the  value  of 
such  bonds.^^ 

Worthless  Debts.  For  the  purpose  of  deduction  as 
losses,  debts  are  divided  into  two  classes,  (a)  those  which 
represent  to  the  creditor  a  return  of  capital  and  (b) 
those  which  represent  unpaid  income.  The  former  may 
be  deducted  regardless  of  when  the  debt  became  due  and 
payable,  but  the  latter,  such  as  uncollected  wages, 
salaries,  rents,  interest  and  items  of  similar  taxable 
income,  may  not  be  deducted,  if  the  debt  became  due 
on  or  after  March  1,  1913,  unless  the  amount  thereof 
has  been  reported  as  income ;  but  if  the  debt  became  due 
and  payable  prior  to  March  1,  1913,  it  may  be  deducted 
in  any  event.^^  The  losses  which  may  be  deducted  are 
losses  of  capital;  income  on  which  the  tax  has  been 
assessed  assumes  the  status  of  capital,  and  income  which 
became  due  and  payable  before  the  incidence  of  the  tax 
is  capital  to  the  taxpayer  although  it  may  be  received 
thereafter.    The  mere  failure  to  receive  income  does  not 

31  T.  D.  2152. 
38  T.  D.  2224. 


DEDUCTION   OP   LOSSES  343 

warrant  a  deduction,  as  the  omission  of  such  amounts 
operates,  in  itself,  as  a  reduction  of  the  tax. 

Must  Be  Charged  off  on  Books.  The  law  expressly 
provides  in  the  case  of  individuals  that  worthless  debts 
must  have  been  "charged  off"  in  the  year  in  which  they 
are  claimed  as  a  deduction.  In  the  case. of  corporations 
such  deduction  must  also  be  evidenced  by  entry  on  the 
books,  as  must  all  losses.'' 

When  Debts  May  Be  Considered  Worthless,  Where 
the  debtor  is  an  individual,  it  is  not  necessary  that  an 
unsatisfied  judgment  shall  exist  or  a  judicial  determina- 
tion be  reached  in  order  that  the  creditor  may  secure  the 
benefit  of  a  deduction  on  account  of  a  debt  which  he  con- 
siders worthless  and  uncollectible;  but  taking  into  con- 
sideration the  time  the  debt  is  over-run  and  the"  financial 
condition  of  the  debtor,  it  is  required  that  it  be  shown 
beyond  a  reasonable  doubt  that  the  debt  is  worthless  and 
uncollectible.  Tf  the  debtor  is  a  corporation,  possessed 
of  assets,  the  debt  cannot  be  claimed  as  a  deduction  except 
for  the  year  in  which  the  debtor  corporation's  affairs 
are  finally  closed  and  its  receiver  in  bankruptcy  dis- 
charged. Where  in  any  case  a  creditor  to  protect  him- 
self from  total  loss  enters  into  a  compromise  agreement 
under  the  terms  of  which  he  accepts  a  part  payment  of 
the  debt  and  releases  the  debtor  from  payment  of  the 
balance,  the  unpaid  portion  may  be  claimed  as  a  deduc- 
tion.'* Whenever  the  debtor  is  legally  discharged  from 
bis  obligation  either  by  the  running  of  the  statute  of 

MAct  of  September  8,  1916,  58 .1  (a)  an<l  12  (a).  R*'^.  .?.".. 
Art.  125. 

84  Letter  from  Treasury  Department  rlntorj  Octoher  16,'  1R17: 
r.  T.  S.  1917.  f  2441. 


344  FEDERAL   INCOME  TAX 

limitation,  by  bankruptcy  proceedings,  by  accord  and 
satisfaction,  by  formal  release,  or  by  any  other  method, 
it  seems  the  creditor  may  claim  the  amount  of  loss  which 
he  sustains  as  a  deduction.  As  indicated  by  the  ruling 
above  it  may  be  possible  under  other  conditions  to  deduct 
the  amount  of  a  debt  but  the  circumstances  must  be  such 
as  to  indicate  beyond  doubt  that  the  debt  cannot  be  col- 
lected. A  mere  voluntary  forgiveness  of  the  debt  would 
not  make  the  amount  thereof  an  allowable  deduction 
since  such  voluntary  action  on  the  part  of  the  creditor 
would  be  tantamount  to  a  gift. 

Unpaid  Instalments.  When  property  has  been  sold 
on  the  instalment  plan  and  the  total  amount  of  notes 
taken  for  the  selling  price  has  been  treated  as  the  equiva- 
lent of  cash  in  reporting  income,  if  subsequently  instal- 
ment payments  are  defaulted,  there  may  be  charged  off 
as  bad  debts  the  amount  of  such  unpaid  instalments, 
less  the  salvage  value  of  the  property  re-possessed.'^ 

Loss  Due  to  Adverse  Judgment.  In  a  case  where  a 
corporation  was  sued  for  infringing  a  trade  name  cover- 
ing a  period  ending  in  1912,  and  judgment  was  obtained 
against  it  in  1916,  the  Treasury  Department  held  that 
the  amount  of  this  judgment  should  be  prorated  over 
the  period  ending  in  1912  according  to  the  income  of 
each  year.  Such  part  as  was  found  by  this  method  to 
be  applicable  to  the  income  of  the  corporation  for  the 
period  1909  to  1912  would  be  referable  to  those  years,  but 
no  part  of  this  sum  would  be  deductible  as  a  loss  in  the 
return  of  income  for  1916.  The  same  corporation  also 
paid,  in  1916,  an  additional  sum,  as  consideration  for 
dismissal  of  a  pending  suit  for  interest  on  the  above  judg- 

36  T.  D.  2090. 


DEDUCTION  OP  LOSSES  345 

ment  from  the  date  of  the  decision  of  the  court  to  the 
date  of  payment  and  for  the  unrestrained  use  of  the 
trade  name  in  question.  It  was  held  by  the  Treasury 
Department  that  if  this  amount  could  be  segregated  be- 
tween interest  and  use,  it  might  be  prorated  the  same  as 
in  the  other  ease,  for  the  period  subsequent  to  1912,  and 
such  part  thereof  as  would  be  found  applicable  to  the 
1916  income  would  be  deductible  under  the  head  of  busi- 
ness expense  and  interest  respectively.  If  no  segrega- 
tion could  be  made  the  entire  amount  might  be  treated 
as  business  expense.'®  This  ruling  was  made,  apparently, 
on  the  theory  that  the  loss  was  not  sustained  in  1916,  but 
in  the  respective  years  when  the  income  was  earned,  but 
the  language  of  the  law  would  better  support  a  conclu- 
sion that  the  entire  loss  was  sustained  in  the  year  the 
adverse  judgment  was  rendered, 

86  Letter  from  Treasury  Department  dated  February  9,  1917; 
I.  T.  S.  1917,  H  2009. 


CHAPTER  32 

DEDUCTION    OP    ALJ.OWANCE   FOR   DEPRECIATION 

In  the  case  of  individuals  the  law  permits  a  reasonable 
allowance  for  the  exhaustion,  wear  and  tear  of  property 
arising  out  of  its  use  or  employment  in  the  business  or 
trade  of  the  individual.  Property  not  used  in  his  busi- 
ness may  not  be  included  in  the  annual  allowance  for 
depreciation.  In  the  ease  of  non-resident  aliens,  the 
property  must  be  within  the  United  States  and  used  or 
employed  in  the  business  or  trade  of  the  non-resident 
alien.  In  the  case  of  corporations,  the  allowance  is  also 
for  the  exhaustion,  wear  and  tear  of  property  arising 
out  of  its  use  or  employment  in  the  business  or  trade, 
limited  in  the  case  of  a  foreign  corporation  to  the  busi- 
ness or  trade  conducted  by  it  within  the  United  States.^ 
The  purpose  of  allowing  a  deduction  each  year  for  de- 
preciation is  to  take  care  of  the  certain  loss  of  property 
which  takes  place  from  year  to  year,  due  to  wear  and 
tear.  The  property  must  be  used  or  employed  in  the 
business  or  trade  of  the  taxpayer.  No  depreciation  is 
allowed  on  a  dwelling  house  occupied  by  the  owner  as  a 
private  residence.* 

Property  Must  Be  Subject  to  Wear  and  Tear.  De- 
preciation as  an  allowable  deduction  in  ascertaining  an- 

1  Act  of  September  8,  1916;  §§  5  (a),  6  (a),  12  (a)  and  12  (b). 
2T.  D.  2153. 

,346 


DfciUUCl'lON    OF    ALLOWANCE   FOR   DEPRECIATION       347 

nual  net  income  for  the  purpose  of  the  income  tax  is  not 
to  be  confused  with  the  deduction  for  loss.  The  de- 
preciation permitted  to  be  taken  as  a  deduction  is  the 
value  assigned  to  the  deterioration  of  physical  improve- 
ments or  assets  such  as  are  susceptible  of  having  their 
value  lessened  through  wear  and  tear.'  Assets  of  any 
character  which  are  not  affected  by  use  and  wear  and 
tear  are  not  subject  to  the  depreciation  authorized  by  the 
law.* 

Loss  IN  Rental  Value  op  Buildings.  The  allowance 
for  depreciation  is  to  make  good  the  wear  and  tear 
suffered  by  property  during  the  tax  year  which,  in  the 
case  of  a  building,  means  the  physical  deterioration 
thereof.  It  does  not  take  into  account  depreciation  in 
value  due  to  a  loss  in  rental  value  because  of  the  con- 
struction of  more  modem  buildings  with  improved  facili- 
ties or  due  to  change  in  the  neighborhood.' 

Real  Estate.  Real  estate,  as  such,  and  as  distinct 
from  the  improvements  thereon,  is  not  reduced  in  value 
by  reason  of  wear  and  tear  and  an  allowance  for  depre- 
ciation in  the  case  of  real-estate  does  not  apply  to  the 
grounds,  but  is  intended  to  measure  the  decline  in  the 
value  of  the  improvements  due  to  wear  and  tear  of  such 
improvements.  In  determining  the  cost  of  real  estate, 
in  most  cases,  no  segregation  is  made  of  the  cost  of  the 
building  as  separate  and  distinct  from  the  cost  of  the 
ground.  In  such  cases  the  value  of  the  ground  should 
be  appraised  and  deducted  from  the  total  cost  of  the 

»T.  D.  2005. 
4T.  D.  2137. 
SColien   V.  Lowe,  234  Fed.  474. 


348  '  FEDERAL   INCOME  TAX 

property    and    the    depreciation    based    upon    the    re- 
mainder.^ 

Farm  Buildings  and  Machinery.  Depreciation  may 
be  claimed  on  farm  buildings  and  farm  machinery  (but 
not  on  the  dwelling  occupied  by  the  owner)  and  also  on 
other  physical  farm  property  subject  to  wear  and  tear.' 

Stock  for  Breeding  Purposes.  A  farmer  may  claim 
depreciation  on  live  stock  purchased  for  breeding  pur- 
poses, but  should  not  claim  depreciation  on  stock  raised 
or  purchased  for  resale,  as  the  cost  of  the  latter  is  an 
expense  of  his  business,  while  the  cost  of  the  former  is 
not  deductible  as  an  expense.* 

Wearing  Apparel.  If  costumes  purchased  by  actors 
and  actresses  are  used  exclusively  in  the  production  of 
a  play  and  are  not  adapted  for  occasional  personal  use, 
and  are  not  so  used,  deduction  may  be  claimed  on  account 
of  such  depreciation  in  their  value  as  occurs  during  the 
year  on  account  of  wear  and  tear  arising  from  their  use 
in  the  production  of  the  play,  or  a  loss  may  be  claimed  if 
they  become  obsolete  at  the  close  of  the  production.^ 

Merchandise.  Depreciation  computed  on  total  in- 
voice value  of  merchandise  in  stock  is  not  an  allowable 
deduction,  since  any  loss  due  to  shrinkage  in  the  salable 
value  of  the  merchandise  will  be  reflected  in  the  sales 
when  the  merchandise  is  disposed  of,  and  inventory  is 

6T.  D.  2137. 

7T.  D.  2153. 

8T.  D.  2153. 

»T.  D.  2090. 


DEDUCTION   OF   ALLOWANCE  FOR  DEPRECIATION       349 

reiiuired  to  be  taken  at  cost.^'^  This  ruling  is  contrary 
to  the  approved  practice  of  taking  inventory  at  cost  or 
at  market  prices,  whichever  is  the  lower.  It  seems  that 
the  Government  would  not  lose  in  the  long  run  by  recog- 
nizing this  accepted  practice  of  conservative  business 
men,  as  the  loss  on  account  of  marking  down  inventory 
would  result  in  a  larger  gain  when  the  goods  were  sold. 
Under  the  provision  of  the  1916  Law  the  Commissioner 
has  power  to  recognize  such  a  practice  and  to  permit  tax- 
payers to  report  on  that  basis. 

Good  Well.  Good  will  does  not  represent  a  value  at- 
taching to  physical  property,  and  is  held  to  be  an  in- 
tangible asset  whose  value,  separate  and  apart  from  the 
business  with  which  it  is  connected,  is  not  capable  of 
determination.  For  the  purpose  of  the  income  tax,  it 
is  capable  neither  of  appreciation  or  depreciation,  hence 
no  claim  for  depreciation  can  be  made  for  the  loss  or 
partial  disappearance  of  good  will.^^ 

Stocks  and  Bonds.  Since  there  is  no  wear  and  tear 
in  the  case  of  stocks  and  like  securities,  no  deduction  can 
be  made  on  account  of  fluctuations  in  their  market 
value.** 

No  Allowance  for  Obsolescence.  The  deduction  for 
depreciation  does  not  contemplate  any  provision  for 
obsolescence,  but  is  limited  to  the  creation  of  a  reserve 
fund  out  of  which  the  loss  due  to  use,  wear  and  tear, 
may  be  compensated.     It  is  not  possible  in  advance  to 

10  See  Instructions  on  Form  1031,  return  of  net  income  of 
corporations. 

11  T.  D.  2137;  Reg.  33,  Art.  136. 
18  T.  D.  2005. 


350  FEDERAL   INCOME   TAX 

determine  when  a  piece  of  machinery,  equipment  or  even 
a  building  will  become  obsolete.  Since  obsolescence  can- 
not be  anticipated,  an  annual  deduction  will  not  be  per- 
mitted to  take  care  thereof.  If  it  happens  that  the  prop- 
erty becomes  obsolete  or  worthless  before  its  estimated 
probable  life  shall  have  expired  a  deduction  representing 
the  difference  between  the  cost  of  the  property  and 
amount  previously  charged  off  on  account  of  deprecia- 
tion may  be  deducted,  as  a  loss,  in  the  year  in  which 
the  property  '  is  determined  to  be  obsolete.^^  In  the 
earlier  rulings  the  Treasury  Department  held  that  de- 
preciation applied  to  tangible  property  subject  to  wear 
and  tear,  exhaustion  or  obsolescence.^*  But  it  seems  that 
the  position  now  taken  is  that  obsolescence  is  not  contem- 
plated by  the  provision  of  the  law  relating  to  deprecia- 
tion, and  that  no  other  provision  of  the  law  permits  an 
annual  allowance  with  respect  thereto,  since  neither  the 
time  when  property  may  become  obsolete,  nor  the  loss, 
when  the  stage  of  obsolescence  is  reached,  can  be  deter- 
mined with  any  degree  of  certainty  in  advance. 

Depreciation  Based  on  Cost  of  Property.  The  amount 
which  may  be  claimed  as  the  total  allowance  for  deprecia- 
tion, that  is,  the  aggregate  of  the  several  annual  allow- 
ances is  the  cost  of  the  property,  not  its  value  at  any  par- 
ticular time.  Unearned  increment  will  not  be  considered 
in  fixing  the  value  on  which  depreciation  shall  be  based.^^ 
The  theory  on  which  depreciation  is  based  is  that  the  in- 
dividual shall  have  returned  to  him  at  the  time  the 
property  is  exhausted  an  amount  equivalent  to  his  in- 

18  Letter  from  Treasury  Department  dated  September  19,  1916: 
T.  T.  S.  1917,  nil  1365  to  1367. 

14  Reg.  33,  Art.  129;   T.  D.  2005;  T.  D.  2077;  T.  D.  2090. 

15  Reg.  33,  Art.  146. 


DEDUCTION   OP   ALLOWANCE  FOR  DEPRECL\TION       351 

vestment  in  such  property,  in  the  form  of  annual  allow- 
ances which  have  not  been  taxed.  The  cost  of  property 
is  ascertained  without  difficulty  in  most  instances,  but 
where  property  has  been  taken  over  by  a  corporation  in 
exchange  for  stock  a  difficulty  arises  and  it  seems  that 
the  ruling  with  respect  to  the  sale  of  assets  would  apply, 
namely,  that  where  the  property  has  been  taken  over  in 
exchange  for  capital  stock  of  a  par  value  greatly  in 
excess  of  the  true  value  of  the  property,  or  if  the  true 
value  of  the  property  was  greatly  in  excess  of  the  par 
value  of  the  stock  issued  for  it,  a  careful  estimate  of 
the  value  of  such  property  at  the  time  is  was  acquired 
may  be  fixed  and  set  up  as  the  value  representing  the 
cost  of  the  property.*® 

Value  op  Property  as  op  March  1,  1913.  In  claim- 
ing depreciation  the  amount  to  be  taken  care  of  is 
always  the  amount  of  capital  invested  in  the  particular 
physical  property,  and  the  value  of  such  property  as  of 
March  1,  1913,  or  as  of  any  other  date,  is  not  to  be 
taken  into  consideration.*''  The  soundness  of  this  ruling 
may  be  questioned.  In  the  case  of  the  sale  of  property, 
the  law  expressly  provides  that  where  the  property  was 
acquired  prior  to  March  1,  1913,  the  fair  market  price 
or  value  of  such  property  on  March  1,  1913,  shall  be  the 
basis  for  determining  the  amount  of  the  gain  or  loss 
and  the  same  basis  is  fixed  by  the  law  for  claiming  the 
allowance  for  depletion.  It  seems  that  the  rule 
should  apply  with  equal  force  in  the  case  of  depreciation 
even  though  the  law  is  silent.  If  the  property  subject 
to  depreciation  increased  in  value  between  the  time  of 
luirchase  and  March  1,  1913,  the  taxpayer  should  be 

16  T.  D.  2161. 
"T.  D.  2446. 


352  FEDERAL  INCOME  TAX 

permitted  to  add  the  increase  in  value  to  the  original 
cost  and  to  compute  depreciation  on  that  basis,  so  that 
he  might  have  returned  to  him,  at  the  time  the  property 
is  exhausted,  an  aggregate  of  allowances  amounting  to 
the  value  of  the  property  on  that  date,  which  value  was 
capital  to  him  at  the  incidence  of  the  tax.^' 

Book  Values.  The  book  value  of  property  has  no 
relation  to  the  allowance  which  may.  be  claimed  for  de- 
preciation, unless  the  book  value  states  the  cost  of  the 
property.  Fluctuations  in  book  values  cannot  be  taken 
into  consideration.  Either  the  book  value  or  the  intrinsic 
value  of  property  on  which  depreciation  is  claimed  may 
increase  or  decrease  without  affecting  the  rate  of  annual 
allowance.  No  depreciation  may  be  claimed  because  of 
arbitrary  changes  in  the  book  value  of  securities  and 
like  assets,  the  gain  or  loss  with  respect  to  which  will 
be  determined  only  when  such  assets  mature  or  are  sold 
or  disposed  of.^^  The  fact  that  bonds  and  similar  se- 
curities have  been  written  off  at  the  direction  of  the 
Comptroller  of  the  Currency  or  a  state  banking  depart- 
ment is  not  material.  A  mere  book  entry  does  not  con- 
stitute either  loss  or  gain  for  the  purpose  of  the  income 
tax.  The  fact  that  bonds  were  written  off  does  not  neces- 
sarily imply  that  they  are  a  total  loss  nor  is  this  act  a 
conclusive  proof  that  any  loss  occurred  during  the  year 
for  which  the  return  is  made.^® 

18  See  Act  of  September  8,  1916;  §  2  (c),  §  5  (a),  §  10,  §  12  (a) 
and  (b) ;  also  Doyle  v.  Mitchell,  235  Fed.  686;  149  C.  C.  A.  106. 

19  T.  D.  2077. 

80  T.  D.  2152.  If,  however,  the  taxpayer  reports  on  a  basis 
other  than  that  of  cash  receipts  and  disbursements  it  would  seem 
that  the  Commissioner  of  Internal  Revenue  has  authority  to  per- 
mit the  changes  in  book  values  of  securities  to  be  taken  into  con- 
sideration as  a  part  of  the  income  or  loss  for  the  year. 


DEDUCTION   OP   ALLOWANCE  FOB  DEU^RECLVTION       353 

Annual  Allowances  Measured  by  Life  of  Property. 
After  tile  cost  of  property  subject  to  depreciation  has 
been  ascertained,  tlie  annual  allowance  is  determined  by 
dividing  the  cost  by  the  probable  number  of  years  con- 
stituting the  life  of  the  property,  the  result  being  the 
amount  which  may  be  deducted  annually.  The  life  of 
the  property  necessarily  depends  upon  its  character,  the 
use  to  which  it  is  put  and  the  conditions  under  which 
it  is  used.  These  elements  being  taken  into  con- 
sideration taxpayers  are  expected,  as  a  result  of  ex- 
perience and  observation,  very  closely  to  approximate 
the  number  of  years  constituting  the  life  of  the  prop- 
erty.*^ If,  after  property  has  been  used  for  a  certain 
purpose,  it  is  put  to  another  use  by  which  it  deteriorates 
more  rapidly  the  allowance  for  depreciation  may  be  in- 
creased accordingly.  In  estimating  the  life  of  the  prop- 
erty it  is  assumed  that  the  owner  will  make  such  repairs 
and  renewals  as  are  neeessarj'  to  prevent  undue  de- 
terioration. In  the  case  of  a  building,  for  instance,  de- 
pre{?<ation  is  to  be  based  upon  the  life' of  the  building 
in  the  sense  of  the  number  of  years  the  building  will 
remain  in  a  condition  to  be  habitable  for  the  use  for 
which  it  was  constructed  and  used,  and  not  merely  the 
inunber  of  years  it  will  stand  without  being  condemned 
and  torn  down.  In  determining  the  life  of  the  building 
it  is  a.ssumed  that  the  owner  will  keep  it  in  good  repair.** 

Incidental  Repairs  to  Property  on  Which  Deprecia- 
tion IS  Claimed.  Such  ordinary  incidental  repairs  as 
keep  the  property  in  an  operating  condition  should  not 
be  charged  to  depreciation  reserve,  but  the  cost  should 

81  T.  D.  2152. 

«8  Cohen  v.  Lowe,  234  Fed.  474. 
P.  I.  Tax.— 23 


354  FEDERAL   INCOME  TAX 

be  charged  to  expense.  A  building  or  a  piece  of  ma- 
chinery or  other  equipment,  as  a  whole,  may  deteriorate 
in  value  and  usefulness  by  reason  of  wear  and  tear 
regardless  of  the  fact  that  certain  minor  component  parts 
may  be  renewed,  restored  or  replaced.  The  depreciation 
deduction  contemplates  the  creation  of  a  fund  that  will 
renew,  restore  or  replace  the  original  property,  when  it 
has  become  worn  out  or  exhausted,  regardless  of  the 
renewal  and  restoration  of  parts  that  may  have  been 
made  in  the  meantime.  Hence,  in  addition  to  the  depre- 
ciation deduction,  the  expense  of  incidental  repairs  which 
do  not  add  to  the  value  of  the  property,  but  merely  keep 
it  in  an  operating  condition,  may  be  deducted  as  expense 
in  the  year  in  which  the  repairs  are  made.'^^ 

Renewals  to  Property.  It  is  possible  in  some  in- 
stances that  worn  out  parts  of  a  machine  or  similar 
equipment  may  be  renewed,  one  after  another,  until  the 
original  machine  or  equipment  is  swallowed  up  in  the 
renewed  parts  and  the  machine  or  equipment  is  then  in 
as  good  operating  condition  as  it  was  originally.  In  such 
cases,  if  the  cost  of  renewed  parts  is  charged  to  operating 
expense,  no  deduction  on  account  of  depreciation  should 
be  claimed  as  to  such  machine  or  equipment.  Thus,  in 
the  case  of  pipelines,  by  replacing  one  joint  of  pipe  after 
another  all  may  be  replaced  and,  if  the  expense  of  re- 
placements is  deducted  as  an  operating  expense,  no 
depreciation  fund  should  be  set  up  for  the  purpose  of 
restoring  the  pipeline  as  a  whole.  On  the  other  hand,  if 
a  reserve  is  set  up  to  cover  property  that  may  be  re- 
newed or  restored  part  by  part  until  the  whole  is  renewed, 

23  Letter  from  Treasury  Department  dated  September  19,  1916; 
I.  T.  S.  1917,  im  1356  to  1358. 


DEDUCTION   OP   AIjLOWANCE  FOB  DByRECIATION       355 

the  cost  of  the  renewed  part  should  be  charged  to  the 
depreciation  reserve  fund  and  not  to  expense.** 

Rate  of  Depreciation.  The  annual  allowance  for 
depreciation,  is  required  by  law  to  be  "resonable."  No 
fixed  rates  are  prescribed.  The  rule  which  has  been 
established  contemplates  that  the  taxpayer  shall  deter- 
mine his  annual  deduction  by  dividing  the  cost  of  the 
property  by  the  probable  number  of  years  constituting 
its  life,  in  the  manner  indicated  above,  the  result  being 
the  amount  which  may  be  deducted  annually.** 

Depreciation  op  Apartment  Houses.  In  the  case  of 
an  apartment  house  it  was  held  by  the  court  that  where 
the  Government  had  allowed  3%  of  the  cost  as  annual 
depreciation  the  burden  was  on  the  owner  to  show  that 
the  amount  so  allowed  was  too  small,  the  court  consider- 
ing the  rate  to  be  reasonable  in  this  case.*® 

Annual  Allowance  Must  Be  Entered  on  Books.  A 
reasonable  allowance  for  depreciation  must  be  de- 
termined upon  a  basis  of  the  cost  of  the  property  and  the 

M  Letter  from  Treasury  Department  dated  September  19,  1916; 
I.  T.  S.  1917,  If  1359  to  1361. 

W  T.  D.  2152.  A  collector  who  told  taxpayers  in  his  district 
that  the  amount  of  depreciation  on  frame  buildings  was  limited 
to  3%,  and  in  case  of  brick  buildings  to  2%,  was  informed 
by  the  Commissioner  of  Internal  Revenue  that  while  these  rates 
might  not  be  far  from  a  reasonable  and  fair  measure  of  de- 
preciation sustained  on  such  buildings,  the  rates  should  not  be 
considered  as  the  "limit,"  as  the  probable  number  of  years  con- 
stituting the  life  of  the  building  might  make  the  rate  more  or 
less  than  the  figures  stated.  Letter  from  Treasury  Department 
dated  May  22,  1916;  I.  T.  S.  1917,  1 1381. 

W  Cohen  v.  Lowe,  234  Fed.  474. 


356  FEDERAL   INCOME  TAX 

probable  number  of  years  constituting  its  life.  The 
amount  of  allowable  depreciation  deduction,  thus  ascer- 
tained, should  be  credited  to  a  depreciation  reserve  ac- 
count, against  which  account  will  be  charged  the  cost  of 
renewing  or  replacing  the  property  with  respect  to  which 
depreciation  is  claimed.^"''  Such  depreciation  liability 
must  be  reflected  in  the  annual  balance  sheet.^'  A 
journal  entry  alone  is  not  sufficient.'^®  Neither  the  1909 
Law  nor  the  1913  Law  required  that  in  order  to  secure 
a  deduction  for  depreciation  the  amount  claimed  should 
be  written  oflf.  It  was,  nevertheless,  held  by  the  Treasury 
Department  that  a  depreciation  deduction,  in  order  to 
be  allowable,  must  be  so  entered  upon  the  books  of  a 
corporation  as  to  constitute  a  liability  against  its  assets. 
Where  a  corporation  had  claimed  depreciation  without 
writing  off  the  amount  on  its  books  the  corporation  was 
permitted  to  reopen  its  books,  if  it  so  desired,  and  make 
such  entries  as  would  constitute  the  amount  a  liabilitj^ 
against  the  assets  of  the  company,  and  a  charge  against 
the  income  of  the  year  in  which  the  return  was  made. 
Revenue  agents  were  directed  to  give  the  taxpayer  suf- 
ficient time  to  make  such  correct  entries  before  the  claim 
for  depreciation  was  disallowed.  If  a  corporation  re- 
fused or  neglected  to  reopen  its  books  and  write  off  the 
depreciation  claimed  in  a  return  the  amount  claimed  was 
disallowed.  If  the  correct  entries  were  made  for  preced- 
ing years,  the  amount  entered  for  each  year  had  to  be 
such  as  would  have  been  entered  at  the  time  the  books 

27  Letter  from  Treasury  Department  dated  September  19,  1916; 
I.  T.  S.  1917,  11355;   Reg.  33,  Art.  130. 

28  Letter  from  Treasury  Department  dated  February  12,  1915; 
I.  T.  S.  1917,  H  1405. 

29  Letter  from  Treasury  Department  dated  May  18,  1916;  I.  T. 
S.  1917,  If  1428. 


DEDUCTION    OP   ALLOWANCE   FOB   DEl'RECIATION       357 

were  closed.'®  In  a  later  ruling  it  was  held  that,  under 
these  acts,  writing  off  of  depreciation  would  not  be  in- 
sisted upon  in  the  adjustment  of  returns  filed  for  the 
years  1909  to  1915  inclusive.'*  The  1916  Law  does  not 
expressly  require  individuals  to  enter  on  their  books  the 
annual  allowance  for  depreciation  but  with  respect  to 
domestic  corporations  it  does  expressly  provide  that  all 
losses,  including  the  allowance  for  depreciation,  must  be 
"charged  off"  within  the  year.'*  As  to  foreign  corpora- 
tions the  Law  is  silent. 

Reserves  for  Depreciation.  In  early  rulings  it  was 
held  that  depreciation  set  up  on  the  books  and  deducted 
from  gross  income  could  not  be  used  for  any  purpose 
other  than  making  good  the  loss  sustained  by  reason 
of  the  wear  and  tear  or  exhaustion  of  the  property  and 
that  if  any  portion  of  the  depreciation  set  up  was 
diverted  to  any  purpose  other  than  making  good  the  loss 
sustained  by  reason  of  such  depreciation  the  amount 
would  be  disallowed.  It  was  also  held  that  the  invest- 
so  Letter  to  Ck)llector8  dated  August  27,  1914;  I.  T.  S.  1917, 
1 1368. 

81 T.  D.  2481,  dated  April  10,  1917.  In  the  meantime  the 
courts  bad  held,  under  the  1909  Law,  that  the  contention  that 
no  allowance  for  depreciation  could  be  «*laimed  unless  it  wa« 
entered  on  the  books  of  the  company,  recorded  from  time  to  time, 
was  without  force  (U.  .8.  v.  Nipissing  Mines  Co.,  202  Fed.  803) 
and  that  the  fact  that  a  deduction  was  incorrectly  carried  on  the 
books  in  surplus  account  did  not  justify  the  Government  in  dis- 
allowing it.  Forty-Fort  Coal  Co.  v.  Kirkendall,  2^3  Fed.  704. 
The  Supreme  Court  of  the  United  States  declined,  in  Strattons' 
Independence  Limited  v.  Howbert,  to  answer  the  question  as  to 
whether  or  not  a  book  entry  was  necessary,  since  the  question  was 
not  properly  brought  before  the  court  in  that  proceeding. 

8«See  Act  of  September  8,  1916.  $8  5  (a),  6  (a"),  12  (a^  and 
12  (b). 


358  FEDERAL   INCOME  TAX 

ment  of  depreciation  reserve  funds  in  additions,  better- 
ments and  improvements  was  not  contemplated  by  the 
law.^^  The  present  ruling  holds  that  the  words  ' '  charged 
off,"  in  the  statute,  mean  that  the  allowance  for  depre- 
ciation is  to  be  credited  to  an  appropriate  reserve  account 
and  be  carried  as  a  liability  against  the  assets,  to  the 
end  that  when  the  total  of  these  credits  equals  the  capital 
investment  account  no  further  deductions  will  be  allowed. 
There  is  no  requirement  of  law  that  the  funds  represented 
by  these  reserve  liabilities  shall  be  held  intact  or  remain 
idle  against  the  day  when  they  may  be  used  in  making 
good  the  depreciation  of  the  property  with  respect  to 
which  the  deduction  is  claimed,  or  in  restoring  the 
capital  investment  in  the  depleted  assets.  The  deprecia- 
tion reserve  may  be  invested  in  assets  of  any  kind.^* 

Deduction  by  Lessees.  Where  a  corporation  issues 
all  of  its  capital  stock  for  cash  and  expends  this  capital 
in  the  erection  of  a  building  upon  a  plot  of  land  which 
it  holds  under  lease,  the  lease  requiring  the  lessee  to 
erect,  operate  and  maintain  a  building  and  providing 
that  at  the  end  of  the  lease  the  building  and  improve- 
ments then  on  the  land  shall  be  surrendered  to  the  lessor 
without  compensation,  the  lessee  may  claim  depreciation 
on  the  building  through  annual  deductions  based  on  the 
cost  of  the  building  and  its  estimated  life,  or  the  life  of 
the  lease,  whichever  is  the  shorter.^^  This  rule  would 
hold  true  in  the  case  of  any  tenant  who  invests  capital 
in  permanent  improvements  or  buildings  on  the  real 
estate  of  the  landlord,  unless  it  is  expressly  provided  by 

88  Reg.  33,  Arts.  132  and  133,  T.  D.  2137. 
34  T.  D.  2481. 

36  Letter  from  Treasury  Department  dated  February  27,  1917; 
I.  T.  S.  1917,  I  2064. 


DEDUCTION   OP   ALLOWANCE   FOR  DE1>RECL\TJ0N       359 

contract  that  title  to  the  property  shall  remain  in  the 
tenant  after  the  lease  expires;  in  the  case  contract  so 
provides,  the  annual  depreciation  would  be  measured 
by  the  life  of  the  property  without  regard  to  the  period 
of  the  lease. 


CHAPTER  33 

DEDUCTION  OP  ALLOWANCE  FOB  DEPLETION  OF  OKi  AND  GAS 
DEPOSITS 

The  law  provides  that  there  may  be  deducted  "in  the 
case  of  oil  and  gas  wells,  a  reasonable  allowance  for 
actual  reduction  in  flow  and  production,  to  be  ascer- 
tained not  by  the  flush  flow,  but  by  the  settled  production 
or  regular  flow. "  ^  It  is  also  provided  that  when  the 
allowance  so  authorized  is  equal  to  the  capital  originally 
invested,  or,  in  the  case  of  purchase  made  prior  to  March 
1 ,  1913,  the  fair  market  value  as  of  that  date,  no  further 
allowance  shall  be  made.  The  provisions  for  depletion 
are  the  same  with  respect  to  corporations  and  indivi- 
duals. The  Treasury  Department  holds  that  this  provi- 
sion of  the  law  applies  only  to  the  owner  of  the  property 
from  which  oil  or  gas  i^  produced,  and  that  the  lessee 
is  not  entitled  to  any  claim  for  depletion  since  one  operat- 
ing under  a  lease  has  no  capital  invested  in  the  property. 
This  seems  to  be  a  very  narrow  construction  of  the  lan- 
guage of  the  law.  But  the  theory  on  which  the  Treasury 
Department  proceeds  is  that  whatever  capital  the  lessee 
may  have  invested  is  not  in  the  deposit  but  in  the  physi- 
cal property  used  in  operating  the  property  on  whieli 
depreciation  may  be  claimed,  or,  if  a  "bonus"  has  been 
paid,  that  it  is  in  the  nature  of  advance  payment  of 
royalties,  and  the  amount  thereof  may  be  ratably  dis- 

1  Act  of  September  8,  1916,  §  5  aiid  §  12. 

360 


DEPLETION  OP  OIL  AND  GAS  DEPOSITS  361 

tributed  over  the  life  of  the  lease  or  over  the  productive 
life  of  the  property,  as  is  further  indicated  in  a  following 
paragraph  on  the  subject  of  lessees.  A  broader  con- 
struction of  the  law  would,  however,  lead  to  the  conclu- 
sion that  the  claim  of  allowance  for  depletion  should  be 
made  with  respect  to  the  capital  invested  in  a  natural 
resource  either  by  the  owner,  the  lessee,  or  the  operator 
all  of  whom  may  have  capital  invested  in  the  deposit. 
The  amount  a  lessee  pays  the  owner  for  the  right  to 
operate  a  property  and  produce  the  oil  or  gas  is  capital 
invested  by  him  in  the  natural  resource.  The  amount  a 
successor  of  a  lessee  pays  the  lessee  for  the  rights  under 
a  lease  is  capital  invested  by  such  successor.  A  lessee 
who  pays  nothing  but  annual  royalties  to  the  owner 
may  also  have  capital  invested  in  the  natural  deposit, 
the  amount  in  such  case  lieing  the  total  of  all  the  amounts 
expended  in  developing  the  property  before  it  begins 
to  produce  ( unless  any  such  amounts  are  deducted  from 
his  net  income  from  other  sources),  and  such  amounts 
as  are  expended  after  the  property  begins  to  produc^e  and 
are  not  charged  to  expense.  The  Treasury  Department 
does  not  di.sallow  an  annual  claim  for  these  amounts 
but  does  not  permit  them  to  be  claimed  under  the  liead 
of  depletion.  The  right  to  claim  the  allowance  for  deple- 
tion is  limited  strictly  to  the  owner  of  the  property  from 
which  the  oil  or  gas  is  produced. 

Depreciation  Not  Included  in  Depletion.  The  de- 
pletion allowance  has  no  relation  to  the  allowance  for 
depreciation  due  to  exhaustion,  wear  and  tear  of  the 
l>hy.sical  property  used  in  tlic  discovery  or  removal  of 
the  natural  deposit.  Thf  allowance  for  depreciation 
should  be  computed  separately  and  apart  from  the  allow- 
ince  for  depletion,  and  should  be  determined  according 


362  FEDERAL   INCOME  TAX 

to  the  rules  laid  down  with  respect  to  depreciation.  Thus, 
depreciation  would  be  allowed  on  rigs,  tools,  machinery 
of  all  kinds,  pipes,  casing,  and  other  equipment  necessary 
to  the  operation  of  the  wells  or  the  field.  Such  deduction 
for  depreciation  may  be  taken  by  the  owner  of  the 
physical  property  whether  he  be  the  owner,  the  lessee, 
or  the  operator  of  the  natural  deposit  with  respect  to 
which  depletion  is  claimed.'' 

Oil  Wells.  The  same  rule  is  laid  down  by  the  1916 
Law  for  computing  depletion  of  oil  wells  and  of  gas 
wells.  Under  the  1909  Law  the  regulations,  prescribing 
the  method  for  claiming  depletion  with  respect  to  each, 
were  different.  With  respect  to  oil  wells  the  depletion 
was,  at  that  time,  based  upon  a  unit  value  per  barrel,  as 
is  further  indicated  by  the  paragraphs  at  the  close  of 
this  chapter. 

Gas  Wells.  Under  the  1916  Law  the  depletion  for  gas 
wells  is  measured  by  the  reduction  in  flow  and  production 
in  the  same  manner  as  in  the  case  of  oil  wells.  Under 
the  1909  Law  the  Treasury  Department  ruled  that  de- 
preciation of  gas  wells  could  be  made  on  the  basis  of 
reduction  in  rock  pressure,  or  reduction  of  volume,  at 
the  option  of  the  tax  payer.  The  present  law  has  been 
criticized  by  owners  of  gas  wells  on  the  ground  that  to 
determine  depletion  by  gauge  of  the  open  flow  of  each 
well  necessitates  a  waste  of  gas  in  order  to  obtain  an 
accurate  test,  and  it  is  contended  that  the  method  of 
using  rock  pressure  would  more  nearly  represent  the 
flow  from  year  to  year  than  any  test  of  volume.  A 
gas  well  is  not,  like  an  oil  well,  usually  operated  to 
get  the  greatest  production  at  all  times.     Depletion  in 

2T.  D.  2447. 


DEPLETION   OP   OIL  AND   GAS  DEPOSITS  363 

the  case  of  gas  wells  is  sometimes  measured  by  the  use 
of  a  minute  pressure  volume  gauge,  which,  though  not 
accurate,  is  valuable  for  comparative  purposes.  Under 
the  present  law,  however,  the  Treasury  Department  rec- 
ognizes only  one  measure  of  depletion  and  that  is  by 
the  expensive  process  of  determining  the  reduction  -in 
flow. 

Owner  Entitled  to  Claim  Deduction.  The  rulings 
are  that  the  owner  of  the  gas  or  oil  well  may  deduct 
annually  "a  reasonable  allowance  for  actual  reduction 
in  flow  and  production  to  be  ascertained  not  by  the  flush 
flow,  but  by  the  settled  production  or  regular  flow." 
The  owner  who  claims  the  deduction  must  be  the  owner 
during  the  period  for  which  the  deduction  is  claimed.' 
Lessees  are  not  permitted  to  claim  an  allowance  for  de- 
pletion as  they  have  no  capital  invested  in  the  property. 

Ba,sis  of  Deduction.  The  amount  on  which  the  annual 
allowance  is  based  is  either  (a)  the  amount  originally 
paid  for  the  property  (not  including  the  cost  of  ma- 
chinery, buildings,  or  other  physical  property  subject 
to  wear  and  tear  connected  therewith)  or  (b)  the  fair 
market  value  of  the  oil  or  gas  deposits  on  March  1,  1913, 
if  the  property  was  purchased  prior  to  that  date.  When 
this  amount  has  been  reached  by  a  series  of  annual  al- 
lowances no  further  allowance  is  permitted  for  depletion. 
In  order  to  determine  when  allowances  for  depletion  shall 
cease,  the  owner  of  the  property  must  keep  an  accurate 
ledger  account,  in  which  shall  be  charged  the  value  or 
cost,  as  the  case  may  be,  of  the  property  with  respect 
to  which  the  allowance  is  claimed.  This  account  must 
be  credited  annually  with  the  amount  allowed  as  a  de- 

8  T.  D.  2447. 


364  FEDERAL   INCOME   TAX 

pletiou  deduction,  and  when  the  account  balances  ao 
further  allowances  may  be  claimed.  The  cost,  or  the 
value  as  of  ]\Iarch  1,  1913,  must  be  fixed  and  set  up  on 
the  books  before  the  first  allowance  with  respect  thereto 
is  claimed.  Once  fixed,  it  cannot  be  changed,  notwith- 
standing the  fact  that  the  quantity  of  oil  or  gas  was 
underestimated  at  the  time  the  value  was  fixed  or  at  the 
time  the  property  was  acquired.* 

Capital  Originally  Invested.  This  phrase,  as  used 
in  the  law,  is  held  to  mean  the  actual  cost  of  the  property 
containing  the  natural  deposit,  but  not  the  cost  of  any 
physical  property  connected  therewith  on  which  deprecia- 
tion may  be  claimed.® 

Fair  Market  Value  as  of  March  1,  1913.  Where  the 
property  was  purchased  prior  to  March  1,  1913,  the  fair 
market  value  as  of  that  date  should  be  taken  instead  of 
the  cost.  Such  fair  market  value  must  be  determined 
by  each  owner,  upon  such  basis  as  will  not  comprehend 
any  operating  profits,  the  estimated  value  in  all  cases 
being  subject  to  the  approval  of  the  Commissioner  of 
Internal  Revenue.  The  estimate  should  be  an  estimate 
of  the  price  at  which  the  property  as  an  entirety  might 
have  been  sold  for  cash  or  its  equivalent  on  March  1, 
1913.®  Although  the  Treasury  Department  does  not 
recognize  the  right  of  a  lessee  to  claim  depletion,  it 
seems  that  where  a  lessee  had  a  leasehold  interest  on 
March  1,  1913,  he  should  be  permitted  to  claim  depletion 
pn  the  value  thereof  at  that  time,  as  such  value  repre- 

4T.  D.  2447. 
6  T.  D.  2447. 
6  T.  D.  2447. 


DEP1.ETION    OF   OIL    AND   OAS   DEPOSITS  365 

sented  capital  to  him  at  the  incidence  of  the  tax,  on 
which  he  sustains  a  loss  as  the  deposit  is  removed. 

Rate  of  Annual  Deductions.  The  annual  deductions 
must  be  reasonable  in  amount;  that  is,  such  sums  as 
will  in  the  aggregate  equal  the  capital  originally  invested 
(or  the  value  on  March  1,  1913)  at  or  about  the  time  the 
deposit  is  exhausted.  The  allowance  is  for  actual  redwe- 
tion  in  flow  and  production  during  the  year  and  not  on 
a  unit  value  basis  as  in  the  case  of  mines.  The  Treasury 
Department  has  ruled  that  this  decline  in  flow  and  pro- 
duction should  be  reduced  to  a  percentage  basis  and  a  like 
percentage  of  the-capital  invested  (or  value  on  March  1, 
1913)  constitutes  the  allowable  deduction  for  the  year. 
That  is,  if  the  decline  in  the  flow  and  production  during 
the  year  of  ten  wells,  costing  $100,000,  has  been  5%,  as 
compared  with  the  production  and  flow  indicated  by  a 
test  made  at  the  beginning  of  the  period,  then  5%  of 
$100,000  will  be  the  allowance  for  that  year.  Where  the 
property  contains  more  than  one  well,  the  percentage  of 
reduction  for  each  well  may  be  ascertained^  in  wliich 
case  the  average  percentage  of  reduction  for  all  the  wells 
would  determine  the  percentage  of  original  cost  or  value 
which  may  be  taken.  The  depletion  deduction  in  all 
•  ases  until  the  capital  is  extinguished  will  be  such  per- 
centage of  the  capital  as  a  reduction  in  the  flow  and 
production  of  one  year  'is  a  percentage  of  the  flow  or 
production  of  the  previous  year.''  It  should  be  noted 
that  by  this  method  of  determining  depletion,  no  allow- 
ance can  be  claimed  so  long  as  the  oil  or  gas  wells  show 
no  reduction  in  the  settled  or  regular  flow.  Thus,  a  well 
may  show  only  a  5%  reduction  in  flow  annually  for  two 
years,  and  in  the  third  year  may  stop  altogether;  the 

7T.  D.  2447. 


366  FEDERAL   INCOME  TAX 

ninety  per  cent  loss  in  the  third  year  may  be  deducted, 
but  is  of  no  avail  unless  the  taxpayer  has  other  income 
suflfieient  to  offset  it.  A  more  equitable  basis  would  be 
to  allow  a  reasonable  deduction  during  the  years  that 
the  well  produces  its  maximum,  on  a  per  unit  value  basis, 
as  in  the  case  of  mines,  the  allowance  stopping  when 
the  capital  has  been  returned  to  the  owner. 

• 

Reduction  of  Production  and  Flow.  The  reduction 
of  production  and  flow  in  the  case  of  a  fully  developed 
territory,  where  no  new  wells  are  being  drilled,  may 
be  ascertained  by  a  comparison  of  the  quantity  produced 
during  the  year  with  the  quantity  produced  during  the 
preceding  year.  That  is,  where  the  production  in  one 
year  is  50,000  barrels  and  the  production  in  the  follow-' 
ing  year  is  47,500  barrels,  this  would  indicate  a  reduc- 
tion in  production  of  2,500  barrels  or  a  decline  of  5%. 
Applying  this  rate  to  the  capital  or  value,  would  de- 
termine the  amount  of  the  annual  allowance.  Where  a 
property  contains  more  than  one  well,  the  reduction  may 
be  determined  with  respect  to  each  well,  or  with  respect 
to  groups  of  wells,  or  with  respect  to  all  the  wells  in  the 
field  or  territory  owned  by  the  taxpayer.  The  taxpayer 
has  the  option  of  measuring  the  reduction  by  individual 
wells,  or  groups  of  wells,  or  the  entire  field,  but  is 
required  to  state  the  method  pursued,  in  a  statement  to 
be  attached  to  the  return  of  annual  net  income.  If  wells 
are  not  so  situated  that  their  flow  and  production  may 
be  assembled  in  order  to  test  and  ascertain  the  reduction, 
as  a  group,  it  is  necessary  to  Wke  an  accurate  gauge  of 
each  well  at  a  certain  same  period  of  each  year  and  by 
comparing  this  gauge  with  that  of  the  previous  year  der 
termine  the  percentage  of  reduction  applying  to  each 
well.     This  having  been  done,  the  average  percentage 


DEPLETION  OP  OIL  AND   GAS  DEPOSITS  367 

reached  for  all  the  wells  on  the  property  will  be  used  in 
ascertaining  the  amount  of  the  deduction.  If  the  deple- 
tion deduction  is  computed  for  a  group  of  wells  or  an 
entire  field  and  new  wells  are  drilled,  the  flow  from  the 
new  wells  may  offset  the  reduction  of  the  other  wells,  but 
no  allowance  can  be  claimed  so  long  as  the  flow  of  the 
unit,  that  is,  the  group  of  wells  or  the  entire  field,  is  as 
great  for  the  year  as  it  was  for  the  preceding  year. 
Hence,  if  the  depletion  allowance  is  to  be  availed  of  in 
the  case  of  a  field  or  territory  in  which  new  wells  are 
being  drilled,  each  individual  well  should  be  tested  at 
the  end  of  the  year  in  order  to  determine  the  reduction 
thereof,  or  possibly  each  group  of  wells  in  operation  at 
the  beginning  of  the  year  and  each  group  brought  in 
during  the  year  as  separate  units.  New  wells  or  new 
groups  of  wells  brought  in  during  the  year  may  be  tested 
as  soon  as  they  have  reached  the  stage  of  settled  produc- 
tion or  regular  flow^and  then  again  at  the  end  of  the 
year,  the  difference  between  the  two  tests  determining 
the  amount  of  reduction,  if  any."  Subsequently  in  the 
case  of  producing  wells  the  tests  for  reduction  must  be 
approximately  one  year  apart  and,  it  seems,  should  pref- 
erably be  at  the  beginning  or  end  of  the  calendar  or  fiscal 
year  of  the  owner. 

Deductions  by  Lessees.  Although  a  lessee  is  not  per- 
mitted by  the  Treasury  Department  to  claim  a  deduc- 
tion for  depletion  he  may  claim  three  deductions  with 
respect  to  the  property:  (a)  for  royalties  paid  during 
the  year;  (b)  for  an  aliquot  part  of  any  "bonus"  paid 
in  addition  to  royalties,  and  (c)  for  depreciation. 

Royalties.  In  many  states,  under  the  terms  of  oil 
and  gas  leases,  it  is  the  custom  to  pay  a  rental  to  the 

»T.  D.  2447. 


368  FEDERAL   INCOME  TAX 

land  owner,  usual  quarterly  and  usually  at  the  rate  of 
one  dollar  per  acre,  per  annum,  for  the  right  to  postpone 
or  delay  the  drilling  of  oil  on  the  land.  When  the  well 
is  drilled  and  oil  is  produced,  the  oil  royalty  is  usually 
paid  in  kind,  generally  one-eighth  of  the  oil  produced 
and  saved.  In  case  gas  is  produced,  the  royalty  is  not 
paid  in  kind,  but  usually  in  cash  at  a  certain  sum  per 
annum  for  each  well.  The  delay  rental  is  income  to  the 
owner,  without  any  allowance  for  depletion,  and  is  a 
proper  item  to  be  deducted  as  expense  by  the  lessee.  If, 
after  production  begins,  the  rental  is  paid  in  kind,  that 
is,  in  oil  or  gas,  the  income  of  the  owner  is  the  amount 
he  receives  on  the  sale  of  his  share,  and  the  income  of 
the  lessee  is  the  amount  he  receives  on  the  sale  of  the 
share  retained  by  him.  From  the  amount  the  lessee  re- 
ceives in  such  cases  no  deduction  can  be  made  on  account 
of  the  rental  paid  in  kind.  If  the  lessee  retains  the 
entire  output  of  the  well,  and  pays  a  rental  or  royalty 
in  cash,  he  must  report,  as  his  income,  the  amount  re- 
ceived on  the  sale  of  the  entire  output,  but  may  deduct, 
as  expense,  the  amount  of  the  cash  ro.yalt.y  paid  to  the 
owner. 

"Bonus."  The  regulation  of  the  Treasury  Depart- 
ment provides  that  if  a  lessee,  in  order  to  secure  the 
right  to  enter  upon,  explore,  develop  or  operate  gas  or 
oil  properties,  paid  or  shall  pay,  a  bonus  in  addition 
to  royalties,  the  ajnount  of  such  bonus  so  paid,  maj'^  be 
ratably  distributed  over  the  life  of  the  lease  or  over  the 
productive  life  of  the  property,  and  the  lessee  may  deduct 
■  annually,  as  a  rental  payment,  an  aliquot  part  of  the 
amount  of  the  bonus  so  paid,  until  such  amount  has 
been  extinguished.  The  word  "bonus"  as  here  used 
means  the  amount  paid  by  a  lessee  for  the  right  to  enter 


DEPLETION   OP   OIL   AND   GAS   DEPOSITS  369 

upon,  explore,  develop,  or  operate  gas  or  oil  properties, 
lu  other  words,  it  is  the  amount  he  may  pay  for  the 
lease  in  addition  to  the  annual  royalties.  One  purchas- 
ing a  lease  from  the  previous  lessee  should  consider  the 
amount  paid  for  such  lease  as  a  "bonus"  to  be  deducted 
ratably  each  year.  Thus,  if  A  acquires  a  lease  from 
the  owner  of  the  land,  upon  agreement  to  pay  an  annual 
royalty  of  one-eighth  of  the  oil  produced,  he  can  neither 
flaim  an  annual  allowance  for  royalty  nor  a  pro-rata 
allowance  for  ' '  bonus, ' '  and  his  income  from  the  property 
will  be  what  he  receives  upon  the  sale  of  seven-eighths 
of  the  oil  produced.  If,  however,  A  sells  his  leasehold 
to  B  for  one  million  dollars,  B  may  deduct  as  "bonus" 
a  pro-rata  part  of  one  million  dollars,  as  that  sum  is 
an  amount  paid  by  him  to  secure  the  right  to  enter  upon, 
explore,  develop,  or  operate  the  property.  The  pro-rata 
amount  of  "Iwnus"  to  be  deducted  annually  is  deter- 
mined by  dividing  the  amount  of  the  "bonus"  by  the 
number  of  years  constituting  the  life  of  the  lease,  or 
if  the  lease  has  partially  expired  when  it  is  acquired, 
by  the  number  of  years  it  then  has  to  run.  If,  however, 
the  productive  life  of  the  property  is  estimated  to  be 
li'ss  than  the  life  of  the  lea.se  the  amount  of  the  "bonus" 
may  be  divided  by  the  number  of  years  estimated  to  be 
the  productive  life  of  the  property,  in  order  to  deter- 
mine the  annual  deduction.  That  is,  the  purpose  is  to 
permit  the  return  to  the  lessee  of  the  full  amount  of 
"bonus"  in  the  shorter  of  the  two  periods  of  time. 

Depreciation.  Although  the  lessee  is  not  entitled  to 
;my  allowance  for  depletion  of  the  natural  resources,  ho 
may  deduct  as  "depreciation"  the  incidental  expenses 
"f  drilling  wells,  that  is,  such  expenses  as  are  paid  for 
wages,  fuel,  repairs,  etc.  Such  expenses  do  not  neces- 
F.  T.  Tax.— 24 


370  FEDERAL   INCOME  TAX 

sarily  enter  into  and  form  a  part  of  the  capital  invested 
or  property  account  and  they  may,  at  the  option  of  the 
one  operating  the  property,  be  charged  either  to  property 
account  or  deducted  from  gross  income  as  an  operating 
expense.  The  practice  among  many  operators  seems 
to  be  to  charge  such  expenses  to  property  account  until 
the  field  begins  to  produce,  and  thereafter  to  charge 
the  cost  of  drilling  additional  wells  in  the  same  field  to 
expense,  that  is,  so  long  as  the  property  is  not  producing 
income  the  expenditure  is  properly  added  to  the  property 
account,  and  depreciation  claimed  in  subsequent  years 
against  the  income  of  the  property  but  after  the  prop- 
erty commences  to  produce  the  amount  is  properly 
charged  against  the  current  income  from  production. 
The  cost  of  drilling  dry  or  non-productive  wells  may 
be  claimed  as  a  loss.  Depreciation  may  also  be  claimed 
on  the  cost  of  all  physical  property  connected  with  the 
operation,  such  as  rigs,  tools,  machinery  of  all  kinds, 
pipes,  casing,  and  other  equipment,  unless  repairs  and 
renewals  are  made  each  year  to  such  an  extent  that  no 
depreciation  occurs  and  such  repairs  and  renewals  are 
charged  to  expense. 

Statement  to  Be  Attached  to  Animal  Return.  Where 
depletion  is  claimed  under  the  above  rules  there  should 
be  attached  to  each  return  made  by  the  individual  or 
corporation  owning  and  operating  oil  or  gas  properties, 
a  statement  showing;  (a)  the  fair  market  value  of  the 
property  (exclusive  of  machinery,  equipment,  etc.)  as 
of  March  1,  1913,  if  acquired  prior  to  that  date,  or  (b) 
the  actual  cost  of  the  property,  if  acquired  subsequent  to 
that  date ;  how  the  fair  market  value  of  the  property  as 
of  March  1,  1913,  was  ascertained,  the  quantity  of  oil 
or  gas  produced  during  the  year  for  which  the  return 


DEPLETION    OP  OIL   AND   GAS  DEPOSITS  371 

was  made  J  the  quantity  produced  during  the  year  im- 
mediately preceding;  how  the  depletion  deduction 
claimed  in  the  return  was  computed,  whether  upon  the 
decline  in  flow  and  production  of  individual  wells,  groups 
of  wells,  or  the  entire  field;  and  any  other  data  which 
will  be  helpful  in  determining  the  reasonableness  of  the 
depletion  deduction  claimed  in  the  return. 

Statement  by  Lessee.  If  the  operator  is  a  lessee, 
that  fact  should  be  stated  and  an  explanation  given  as 
to  the  basis  and  property  upon  which  any  depreciation 
deduction  is  claimed,  that  is,  depreciation  due  to  use, 
wear  and  tear  of  physical  property,  the  lessee  not  being 
entitled  to  any  deduction  for  depletion  or  exhaustion  of 
the  oil  or  gas  products,  but  being  entitled  to  deduct  an- 
nually as  a  rental  payment,  an  aliquot  part  of  any 
stipulated  sum  or  bonus  paid  for  the  right  to  enter  upon, 
explore,  develop  and  operate  oil  or  gas  territory,  as  well 
as  the  royalty  payments  made  to  the  lessor  for  the  oil 
or  gas  removed  from  such  property,  provided  the  entire 
proceeds  from  the  oil  or  gas  produced  during  the  year 
are  returned  in  the  gross  income  of  the  operator.* 

Rule  Under  1913  Law.  The  1913  Law  made  no  ex- 
press provision  for  an  allowance  for  depletion  of  oil  and 
gas  wells  and  the  Treasury  Department  made  no  rulings 
outlining  any  method  of  claiming  such  depletion. 

Rule  Under  1909  Law.  Under  the  1909  Law,  which 
was  silent  on  the  subject  of  depletion,  the  Treasury  De- 
partment permitted  allowances  for  depreciation  of  oil 
wells.  Owners  were  required  to  adopt  an  average  value 
per  barrel  of  the  settled  daily  production  as  the  guide 

»T.  D.  2447. 


372  FEDERAL   INCOME   TAX 

in  determining  the  value  of  the  property  at  the  time  of 
the  incidence  of  the  tax  or  upon  the  date  of  commence- 
ment of  production.  With  this  basis  per  barrel  the  value 
of  the  property  as  a  whole  was  to  be  determined  by  ap- 
plying such  unit  value  per  barrel  to  the  daily  average 
production  for  the  month  of  December,  or  other  repre- 
sentative month  in  the  year  for  which  the  return  was 
made,  the  representative  month  chosen  being  the  same 
in  each  year.  The  same  unit  value  per  barrel  was  to 
be  retained  in  computing  all  future  deductions  for 
depreciation  except  where  an  additional  production  was 
secured  by  drilling,  or  acquired  by  purchase,  in  which 
case  a  new  average  rate  per  barrel  based  upon  the  actual 
cash  invested  might  be  adopted.  The  amount  of  the  al- 
lowance each  year  was  ascertained  by  multiplying  the 
unit  value  by  the  difference  between  the  daily  average 
production  in  barrels  during  the  representative  month 
of  each  year.  It  was  considered  that  by  following  this 
plan  that  the  capital  invested  in  the  producing  property 
would  be  automatically  and  wholly  extinguished  coinci- 
dent with  the  complete  exhaustion  of  the  product,  with 
the  exception  of  such  salvage  as  might  remain  after  the 
exhaustion.^'  In  the  case  of  gas  wells  the  Treasury  De- 
partment permitted  a  deduction  for  depreciation  on  a 
basis  either  of  reduction  of  rock  pressure  or  of  reduction 
of  volume.  The  cost  of  drilling  gas  wells  was  permitted 
to  be  charged  to  investment  or  to  expense  and  the  gen- 
eral custom  of  natural  gas  companies  in  the  distribution 
of  the  cost  of  drilling  wells  was  recognized.^* 

10  T.  D.  1755, 

11  T.  D.  1754. 


CHAPTER  34 

DEDUCTION   OF   .VLLOWANCE   FOR  DEPLETION   OF    MINES 

The  1916  Law  provides  that  individuals  and  corpora- 
tions may  deduct  a  reasonable  allowance  for  the  deple- 
tion of  mines,  not  to  exceed  the  market  value  in  the  mine 
of  the  product  thereof  which  has  been  mined  and  sold 
during  the  year  for  which  the  return  and  computation 
are  made.*  The  allowance  is  to  be  made  under  rules  and 
regulations  to  be  prescribed  by  the  Secretary  of  the 
Trea.sury.  The  purpose  of  permitting  the  allowance  is 
to  enable  the  taxpayer  liaving  capital  invested  in  the 
mining  deposit  to  receive  back  the  capital  originally  in- 
vested, or  in  the  case  of  purchase  made  prior  to  March 
1st,  1913,  the  fair  market  value  of  the  deposit,  or  his 
interest  therein,  as  of  that  date,  and  when  the  aggregate 
of  allowances  reaches  such  sum  no  further  allowance  is 
permitted.  Under  this  provision  of  the  law,  the  Com- 
missioner of  Internal  Revenue,  with  the  approval  of  the 
Secretary  of  the  Treasury',  has  made  regulations  which 
are  discussed  in  the  following  paragraphs. 

Depreciation  Not  Included  in  Depletion.  It  should 
be  borne  in  mind  that  depletion  is  an  allowance  for  the 
wasting  of  the  natural  resources  and  does  not  include 
any  allowance  for  loss  due  to  exhaustion,  wear  and  tear 
of  physical  property  used  in  the  discovery  or  removal 

1  Act  of  September  8,  1916,  f  5  (a)  and  1 12  (a). 

.373 


374  FEDERAL   INCOME  TAX 

of  such  natural  resources.  An  allowance  for  depreciation 
should  be  claimed  separately  and  apart  from  the  allow- 
ance for  depletion  and  should  be  determined  according 
to  the  rules  laid  down  with  respect  to  depreciation,^ 
Depletion  is  a  deduction  allowed  for  the  purpose  of  re- 
turning the  capital  invested  by  a  taxpayer  in  natural  re- 
sources at  or  about  the  time  the  natural  resource  is 
exhausted.  In  addition  to  the  deduction  allowed  to 
measure  the  loss  due  to  depletion  the  taxpayer  will  also 
be  allowed  the  usual  depreciation  of  the  machinery, 
equipment,  etc.,  used  in  connection  with  the  operation 
of  removing  the  natural  resource.' 

Who  May  Claim  Deduction.  The  owner  of  the  mine 
content  or  of  an  interest  therein  is  the  one  who  may 
claim  the  allowance  for  depletion.  Ownership  at  the 
time  for  which  the  computation  is  made  is  essentially 
prerequisite.  Lessees  or  operators  are  not  entitled  to 
any  allowance  for  depletion,  if  they  have  no  capital  in- 
vested in  the  deposit,  but  they  may,  of  course,  deduct  the 
royalties  or  rentals  paid  from  year  j,o  year  to  the  owner. 
If,  however,  a  lessee  has  paid  a  fixed  sum  to  the  owner 
for  the  right  to  explore,  develop  or  operate  a  mine,  the 
amount  so  paid  is  capital  invested  by  him  and  may  be 
ratably  distributed,  either  over  the  life  of  the  lease,  or 
the  probable  life  of  the  mine  under  ordinary  operating 
conditions,  whichever  is  the  shorter,  and  he  may  deduct 
annually,  an  aliquot  part  of  the  amount  so  paid,  until 
such  amount  has  been  extinguished.* 

Basis  of  Deduction.  The  purpose  of  the  deduction 
is  to  permit  the  return  to  the  taxpayer,  free  from  tax,  of 

2T.  D.  2446;  see  Chapter  32. 
3Eeg.  33,  Art.  143. 
4T.  D.  2446. 


DEDUCTION  OP  ALIiOWANCE  FOB  DEPLETION  OF  MINES   375 

either  (a)  the  amount  of  capital  invested  in  the  mine 
(not  including  the  amount  invested  in  mining  machin- 
ery, buildings  or  other  physical  property  subject  to  de- 
preciation) or  (b)  the  fair  market  value  of  his  interest 
in  the  mine  itself  (that  is,  the  mineral  deposit  not  includ- 
ing machinery,  buildings,  etc.)  on  March  1,  1913,  if  the 
property  was  acquired  prior  to  that  date.  When  the 
amount  of  capital  invested,  or  value  at  the  incidence  of 
the  tax,  has  been  extinguished  by  a  series  of  annual 
allowances,  no  further  allowance  will  be  permitted.  For 
this  purpose  the  taxpayer  is  required  to  keep  an  accurate 
ledger  account  showing  the  amount  on  the  basis  of  which 
he  claims  depletion  and  the  amount  of  depletion  de- 
ductions allowed  each  year;  when  the  account  balances 
no  further  deductions  should  be  made.  "The  amount  of 
invested  capital  once  fixed  is  final,  and  a  re-valuation 
will  not  be  allowed  during  the  period  of  the  ownership 
under  which  it  was  determined,  although  it  may  later 
develop  that  the  estftnated  quantity  of  the  mineral  de- 
posit was  understated  at  the  time  such  amount  was  fixed. 
If  the  property  changes  hands,  the  new  owner,  of  course, 
establishes  a  new  basis,  which  will  be  the  price  he  pays 
for  the  mineral  deposit." 

Capital  Invested.  This  phrase,  as  used  in  the  pre- 
ceding paragraph,  means  the  actual  cost  to  the  owner  • 
and,  it  seems,  should  include  not  only  the  original  cost 
of  the  property  (excluding  physical  appurtenances  sub- 
ject to  wear  and  tear  and  consequently  treated  under  the 
head  of  depreciation)  but  also  the  cost  of  development 
work  to  bring  the  property  to  an  operating  condition, 
such  as,  wages,  fees,  taxes  and  other  necessarj'  expenses. 

5  T.  D.  2446. 
6T.  D.  2446. 


376  FEDERAL  INCOME  TAX 

Amounts  expended  after  the  property  begins  to  produce 
income,  should  not  be  charged  to  capital  if  they  are  items 
which  may  be  deducted  from  net  income  for  the  year, 
except  to  the  extent  that  such  expense  of  development 
exceeds  the  incomeJ 

Fair  Market  Value  as  of  March  1,  1913.  If  the 
taxpayer  acquired  mineral  deposit,  or  interest  therein, 
prior  to  March  1,  1913,  the  amount  of  capital  invested, 
which  may  be  extinguished  through  annual  depletion  de- 
ductions, is  the  fair  market  value  of  the  deposit  or  in- 
terest therein  as  of  March  1,  1913.  This  value  must  not 
]ye  based  upon  the  assumed  salable  value  of  the  output 
under  current  operative  conditions  less  cost  of  produc- 
tion, for  the  reason  that  the  value  under  such  conditions 
would  comprehend  the  earning  capacity  of  the  property. 
Neither  should  the  value  "be  speculative,  but  must  be 
determined  upon  the  basis  of  the  salable  value  en  bloc 
as  of  that  date,  of  the  entire  deposit  of  minerals  con- 
tained in  the  property  owned,  exclusive  of  the  improve- 
ment and  development  work ;  that  is,  the  price  at  which 
the  natural  deposits  or  mineral  property,  as  an  entirety, 
in  its  then  condition,  could  have  been  disposed  of  for 
cash  or  its  equivalent.  The  precise  detailed  manner  in 
which  the  estimated  fair  market  value  of  mineral  de- 
posits as  of  March  1,  1913,  shall  be  made,  must  naturally 
be  determined  by  the  taxpayer.  It  must  be  on  such  basis 
as  will  not  comprehend  any  operating  profits.  The  esti- 
mate in  all  cases  is  subject  to  the  approval  of  the  Com- 
missioner of  Internal  Revenue,  and  once  the  value  has 

7  Ascertaining  tlic  cost  for  purpose  of  depiction  sliould  lie  gov- 
erned by  the  same  general  rules  as  apply  to  ascertaining  the  cost 
of  assets  for  the  purpose  of  computing  the  profit  on  the  sale 
thereof.     See  Chapter  20. 


DEDUCTION  OP  ALIX)WANCE  FOR  DEPLETION  OP  MINES   377 

been  fixed  there  can  be  no  re-valuation  if  it  should  be 
found  that  the  estimated  quantity  of  the  mineral  deposit 
was  underetated  at  the  time  the  value  was  fixed.  If  the 
value  as  of  March  1,  1913,  cannot  be  ascertained  in  any 
more  definite  way,  the  original  cost  of  the  mineral  de- 
posit may  be  taken,  allowance  being  made  for  minerals 
which  have  been  removed  prior  to  that  date.^ 

Rate  of  Annual  Deductions.  The  amount  of  allow- 
ance for  depletion,  which  may  be  deducted  each  year  is 
required  by  the  law  to  be  reasonable,  and  is  held  by  the 
Treasury  Department  to  be  such  sums  as  will  reasonably 
amount,  in  the  aggregate,  to  the  capital  invested  at  or 
^bout  the  time  the  deposit  is  exhausted.  The  annual 
allowance  is  limited,  however,  to  an  amount  not  to  exceed 
"the  market  value  in  the  mine  of  the  product  thereof 
which  has  been  mined  and  sold  during  the  year. "  ®  To 
determine  what  is  a  reasonable  amount  and  to  fix  the 
limit  of  the  annual  allowance,  the  Treasury  Department 
has  ruled  that  at  the  time  of  acquiring  ownership,  or  as 
of  March  1,  1913,  as  the  case  may  be,  an  estimate  must 
be  made  of  the  number  of  units  (tons,  pounds,  etc.)  in 
the  deposit.  The  capital  invested  (or  the  value  of  the 
deposit  on  March  1,  1913)  divided  by  this  estimated 
number  of  units  will  determine  the  per  unit  value  of  the 
deposit  in  the  mine,  and  this  per  unit  value  multiplied 

•  T.  D.  2446. 

9  A  question  arises  here  as  to  whether  the  product  mined  in  one 
year  and  sold  in  the  next  can  be  considered  in  fixing  this  limit. 
It  does  not  seem  likely  that  Congnress  in  using  the  phrase  "mined 
and  sold"  contemplated  that  both  operations  must  take  place  in 
the  same  year,  but  rather  that  the  limit  should  be  determined  by 
the  product  sold  during  the  year,  mined  on  the  particular  property 
for  which  allowance  is  claimed. 


378  ■  FEDERAL   INCOME  TAX 

by  the  number  of  units  mined,  and  sold  during  the  year 
will  fix  the  allowance  for  that  year.^® 

Illustration.  As  an  illustration  of  the  method  of 
computing  the  annual  deduction,  suppose  that  the  orig- 
inal investment,  or  the  value  as  of  March  1,  1913,  is 
$50,000,  and  the  estimated  number  of  units  is  one  million. 
The  per  value  unit  will  be  five  cents,  and,  if  one  hun- 
dred thousand  units  are  mined  and  sold  during  the 
year,  the  annual  allowance  for  that  year  will  be  $5,000. 
Assume  that  the  production  and  sale  has  been  main- 
tained at  this  rate  for  five  years ;  one-half  of  the  original 
cost  will  then  have  been  returned  to  the  owner.  If  at 
that  time  the  mine  is  sold  for  $50,000,  and  it  is  then 
ascertained  that  500,000  units  still  remain  in  place  in 
the  deposit,  the  new  owner  may  set  up  $50,000  as  the 
capital  invested  which,  divided  by  500,000  units  will 
allow  him  a  per  unit  value  of  ten  cents,  to  be  multiplied 
by  the  number  of  units  mined  and  sold  each  year  in 
ascertaining  the  annual  deduction  thereafter.  The 
probable  number  of  units  in  a  deposit  cannot  always  be 
estimated  with  any  degree  of  accuracy.  If  the  number 
is  ascertained  in  good  faith,  and  in  the  exercise  of  the 
taxpayer's  best  judgment,  supported  by  such  reports  of 
engineers  or  mining  experts  as  he  may  have,  it  would 
seem  to  be  sufficient.  The  law  requires  the  annual  allow- 
ance to  be  "  reasonable ' '  and  any  reasonable  method  used 
in  estimating  the  extent  of  the  deposit  should  suffice.  It 
does  not  seem  to  be  contemplated  that  an  expensive  sur- 
vey shall  be  undertaken  in  making  the  estimate.  As  the 
per  unit  value  determines  the  rate ,  at  which  depletion 
may  be  claimed,  it  follows  that  the  estimate  should  be 
conservative,  since  a  too  liberal  estimate  of  the  extent 

10  T.  D.  2446. 


DEDUCTION  OP  ALLOWANCE  FOB  DEPLETION  OF  MINES   379 

of  the  deposit  may  find  the  owner  unable  to  claim  his 
full  allowance  before  the  property  is  exhausted. 

Allowajice  on  Each  Separate  Deposit.  Where  a  tax- 
payer owns  more  than  one  mining  property  allowance 
may  be  computed  for  each  separate  mine  or  deposit,  and 
the  aggregate  of  such  computations  constitutes  the  allow- 
ance to  which  he  is  entitled. 

Statement  to  Be  Attached  to  Annual  Return.  Where 
depletion  is  claimed  under  the  above  rules  there  should 
be  attached  to  the  return  of  annual  net  income  of  the 
claimant  a  statement  setting  out  whether  the  operator 
is  a  fee  owner  or  a  lessee ;  in  the  case  of  a  fee  owner,  (a) 
the  fair  market  value  of  the  mineral  deposits  as  of  March 
1,  1913,  if  the  property  was  acquired  prior  to  that  date, 
(b)  the  cost  of  the  mineral  property  if  acquired  subse- 
quent to  that  date;  the  method  by  which  the  value  as 
of  March  1,  1913,  was  determined  in  case  the  property 
was  acquired  prior  to  that  date ;  the  estimated  quantity 
in  units  in  the  mine  as  of  March  1,  1913,  or  at  the  date 
of  purchase,  if  acquired  subsequent  to  that  date;  the 
number  of  units  removed  and  sold  during  the  year  for 
which  the  return  is  made;  and  any  other  data  which 
would  be  helpful  in  determining  the  reasonableness  of 
the  depletion  deduction  claimed  in  the  return.  In  the 
case  of  a  lessee,  the  statement  should  show  (a)  the 
amount  of  the  bonus  or  other  payment  made  for  the 
right  to  operate  the  mine ;  (b)  the  period  covered  by  the 
lease.** 

Rule  Under  the  1913  Law.    The  1913  Law  provided 
for  an  arbitrarv  deduction  in  the  case  of  an  individual 


b 


11  T.  D.  2446. 


380  FEDERAL   INCOME   TAX 

or  corporation  for  the  depletion  of  mining  deposits, 
not  to  exceed  5%  of  the  gross  value  at  the  mine  of  the 
output  for  the  year  for  which  the  computation  was 
made.*''  Under  this  law  it  was  held  that  taxpayers  oper- 
ating mines  or  oil  or  gas  wells  upon  a  royalty  only,  could 
not  claim  depreciation  because  of  the  exhaustion  of  the 
deposit.*^  It  was  also  held  that  in  order  to  claim  a  de- 
duction for  depletion  the  amount  of  such  deduction  had 
to  be  charged  off  on  the  books  so  as  to  constitute  a 
liability  against  the  assets  of  the  taxpayer.  A  general 
ledger  entry  was  required  so  that  the  amount  charged 
off  would  be  reflected  in  the  annual  balance  sheet.**  It 
was  later  held  however,  that  failure  to  write  off  deple- 
tion would  not  result  in  disallowing  the  deduction.*^ 

Rule  Under  the  1909  Law.  Under  the  1909  Law  the 
Treasury  Department  allowed  a  deduction  for  deple- 
tion on  the  unit  value  basis,*^  although  the  law  was 
silent.  "When  a  case  involving  the  question  came  before 
the  Supreme  Court  it  was  held  that  the  fact  that  the 
revenues  derived  from  operating  mines  resulted  to  some 
extent  in  exhaustion  of  the  capital,  established,  under 
that  law,  no  ground  for  deducting  the  value  of  the  ore 
from  the  gross  income  as  depreciation,*''  and,  further, 
that  Congress  did  not  intend  to  cover  the  necessary 
depreciation  of  a  mine,  by  exhaustion  of  the  ores,  in 
determining  the  income  to  be  assessed  under  the  statute, 

12  Act  of  October  3,  1913  If  B  and  KG  (b). 

13  Reg.  33,  Art.  145. 

14  Letter  from  Treasury  Department  dated  May  18,  1916;  1.  T. 
S.  1917,  111428. 

15  T.  D.  2481.  . 

16  T.  D.  1675. 

17Stratton's  Independence  Ltd.  v.  Howbert,  231  U.  S.  339,  34 
Sup.  Ct.  136;  58  L.  Ed.  285. 


DEDUCTION  OF  ALLOWANCE  FX)B  DEPLETION  OP  MINES    381 

hy  including  such  exhaustion  within  the  allowance  for 
depreciation.*'  In  a  later  case,  decided  in  a  lower  court, 
these  decisions  were  held  not  to  apply  to  a  company  min- 
ing ore  by  stripping  off  the  surface  covering  the  deposit, 
the  court  being  of  the  opinion  that  where  a  company 
could  strip  the  surface  from  a  deposit  and  thua  definitely 
and  certainly  ascertain  the  extent  or  character  thereof, 
or  ascertain  it  by  means  of  test  pits,  shafts  and  drilling 
from  the  surface,  the  owner  or  lessee  could  ascertain 
with  certainty  the  value  of  his  property  on  January  1, 
1909,  and  deduct  that  value  from  each  ton  in  ascertain- 
ing the  net  income -under  the  1909  Law.*® 

18  Von  Baumbach  v.  Sargent  Land  Co.,  242  U.  S.  503. 

19  Biwabik  Mining  Co.  v.  U.  S.,  242  Fed.  9. 


CHAPTER  35 

RETURN  OP  ANNUAL  NET  INCOME 

For  the  purpose  of  assessing  the  tax,  a  return  of  an- 
nual net  income  is  required,  showing  the  gross  and  net 
income  for  the  taxable  year.  This  chapter  deals  with 
the  general  provisions  relating  to  returns  of  annual  net 
income,  and  does  not  cover  the  annual  or  special  returns 
required  with  respect  to  withholding  at  the  source,  in- 
formation at  the  source  or  other  matters.  For  a  discus- 
sion of  such  returns  attention  is  directed  to  the  chap- 
ters on  the  respective  subjects. 

By  Whom  Filed.  The  law  requires  the  return  of  an- 
nual net  income  to  be  filed  by  each  person  of  lawful  age 
having  a  net  income  of  $1,000  or  over  for  the  calendar 
year,  if  the  individual  is  unmarried,  and  $2,000  or  over 
if  the  individual  is  married.^  Guardians,  trustees, 
executors,  administrators,  receivers  and  other  fiduciaries 
are  required  to  make  a  return  if  the  income  of  bene- 
ficiaries is  $1,000  or  $2,000  as  indicated  above,  and  as  to 
undistributed   income,    it   seems   that    a   return   is   re- 

1  Act  of  September  8,  1916,  §8  (b),  provides  for  the  filing  of 
returns  by  persons  of  lawful  age  having  a  net  income  of  $3,000  or 
over  for  the  taxable  year  but  this  provision  is  superseded  by  the 
Act  of  October  3,  1917,  §  3,  which  requires  a  return  to  be  filed 
under  conditions  indicated  in  the  context.  The  1917  Law  will 
govern  the  filing  of  returns  until  it  is  repealed  or  amended.  As 
to  non-resident  aliens,  see  Chapter  5. 

382    ^ 


RETUBN   OP  ANNUAL  NET   INCOME  383 

quired  when  such  income  is  $1,000  or  over  for  the  tax- 
able year.*  Elinors  and  incompetents  are  not  required  to 
file  returns  but  their  fiduciaries  are  required  to  file  re- 
turns for  them.  A  return  is  required  from  every  corpo- 
ration subject  to  the  tax  regardless  of  whether  or  not  it 
has  been  in  receipt  of  any  income  during  the  taxable 
year.'  The  terra  "taxable  year"  as  here  used  means  the 
calendar  year,  except  in  cases  where  a  corporation  has 
designated  its  fiscal  year  as  such. 

Husband  and  Wife.  If  a  husband  and  wife,  liv- 
ing together,  have  separate  estates,  the  income  from  both 
may  be  reported  in  one  return,  but  the  amount  of  income 
of  each,  and  the  full  name  and  address  of  both,  must  be 
shown  in  such  return.  Ordinarily,  the  husband,  as  the 
head  and  legal  representative  of  the  household,  and  gen- 
eral custodian  of  its  income,  should  make  and  render  the 
return  of  the  aggregate  income  of  himself  and  his  wife. 
If,  however,  the  wife  does  not  disclose  her  income  to  the 
husband,  each  may  make  a  return,  in  which  case  the  per- 
sonal exemption  may  be  divided  between  the  two  in  such 
proportions  as  they  agree  upon.  If  either  husband  or 
wife  separately  has  an  income  equal  to  or  in  excess  of 
$2,000  a  return  is  required  under  the  law.  If  the  aggre- 
gate income  of  both  is  $2,000  or  more,  the  Treasury  De- 

SAct  of  September  8,  1916,  S8(c))  as  amended  by  Act  of 
October  3,  1917,  requires  no  return  of  net  income  not  exceeding 
$3,000,  but  tliis  provision  is  superseded  by  §  3,  Act  of  October  3, 
1917.  The  law  is  obscure  as  to  returns  of  undistributed  net  income 
of  trust  estates,  but  as  the  specific  exemption  under  the  1917  Law 
is  only  $1,000,  a  return  will  no  doubt  be  required  if  such  income 
exceeds  that  amount. 

8  Act  of  September  8,  1916,  $  13  (a). 


384  FEDERAL   INCOME   TAX 

partment  requires  a  return,  although  neither  may  have 
an  income  of  $2,000.* 

Agents.  When  a  return  is  made  by  any  person  acting 
as  agent  for  the  taxpayer,  the  agent  assumes  the  respon- 
sibility of  making  the  return  and  incurs  the  penalties 
provided  for  erroneous,  false  or  fraudulent  returns.* 
When  the  required  return  has  not  been  made  by  such 
agent  notice  of  failure  to  make  the  return  will  be  served 
upon  him,  and  in  answer  thereto  he  will  be  permitted 
to  file  evidence  with  the  collector  showing  that  the  in- 
dividual for  whom  he  acts  did  not  receive  an  income  sub- 
ject to  tax  during  the  year,  or  that  the  agent  filed  the 
return  with  some  other  collector,^  One  who  acts  as  agent 
does  not,  however,  assume  any  fiduciary  relationship 
within  the  meaning  of  the  income  tax  law  and,  unless 
otherwise  provided,  the  principal  and  not  the  agent  is 
subject  to  the  liability  under  the  law.''^ 

Where  Filed.  The  law  permits  the  filing  of  the  re- 
turn by  an  individual  in  the  district  in  which  such 
individual  has  his  legal  residence  or  principal  place  of 
business,  or,  if  he  has  no  legal  residence  or  place  of  busi- 
ness in  the  United  States,  then  with  the  Collector  of 
Internal  Revenue  at  Baltimore,  Maryland.'     Although 

4  This  statement  is  based  upon  the  ruling  contained  in  Regula- 
tions 33,  Art.  10,  which  held  under  the  1913  Law  that  if  either 
husband  or  wife  had  an  income  of  $3,000  a  return  should  he  filed 
although  the  aggregate  incomes  of  both  might  not  be  $4,000  and 
if  the  aggregate  income  of  both  was  over  $4,000  a  return  should 
be  filed  although  the  individual  income  of  either  one  might  not 
amount  to  $3,000. 

5  Act  of  September  8,  1916,  §  8  (b). 

6  Reg.  33,  Art.  18. 

7  T.  D.  2137. 

8  Act  of  September  8,  1916,  §  8  (a). 


RETUEN  OP  ANNUAL  NET  INCOME  385 

the  law  permits  the  return  to  be  filed  in  either  one  of  the 
two  districts  indicated  above,  the  Treasury  Department 
desires  for  administrative  purposes  that  the  return  be 
filed  in  the  district  in  which  the  individual  resides.® 
Corporations  are  required  to  file  their  returns  with  the 
collector  of  the  district  in  which  is  located  the  principal 
office  of  the  corporation,  where  are  .kept  its  books  of 
account  and  other  data  from  which  the  return  is  pre- 
pared, or,  in  the  ease  of  foreign  corporations,  with  the 
collector  of  the  district  in  which  is  located  the  principal 
place  of  business  in  the  United  States,  or  if  thej{  have 
no  principal  place  of  business,  office,  or  agency  in  the 
United  States,  with  the  Collector  of  Internal  Revenue 
at  Baltimore,  Slaryland.^'' 

When  Filed.  March  1st  is  the  primar}^  due  date  for 
all  returns  of  annual  net  income.  This  due  date  can  be 
changed  by  a  corporation  designating  a  fiscal  year,  in 
which  case  the  sixtieth  day  after  the  close  of  the  fiscal 
year  becomes  the  primary  due  date  on  or  before  which 

9  Letter  from  Treasury  Department  dated  December  17,  1914. 
The  Treasury  Department  recognizes  that  the  individual  has  the 
right  to  choose  one  of  two  districts,  where  he  resides  in  one  an«l 
does  business  in  another,  and  a  filing  in  either  district  will  be  a 
proper  compliance  with  the  law.  For  the  year  1913  the  Treasury 
Department  requested  the  filing  of  returns  in  the  district  in 
which  the  individual 's  principal  place  of  business  was  located. 
This  threw  an  undue  burden  on  the  collectors  in  the  large  cities, 

!  and  the  subsequent  ruling  was  made  in  order  to  remedy  this  con- 
dition. 

10  Act  of  September  8,  1916,  §  13  (b).  As  stated  in  the  chap- 
ter on  corporations  the  principal  oflSce  here  referred  to  is  the 
business  office,  not  the  statutory  office  in  the  state  in  which  the 
corporation  is  incorporated.  The  return  may  be  filed  from  the 
latter  office  only  when  a  domestic  corporation  has  no  other  office 
or  place  of  business  in  this  country. 

P.  I.  Tax.— 25 


386  FEDERAL  INCOME  TAX 

its  return  should  be  filed.  Unless  an  extension  of  time 
is  obtained,  the  taxpayer  will  be  held  delinquent  if  his 
return  is  not  filed  on  or  before  the  primary  date  and 
will  be  subject  to  the  50%  additional  tax  and  penalty 
of  the  law.^^ 

Last  Due  Date;  These  words  are  used  to  designate 
the  last  day  upon  which  a  return  may  be  filed  without 
penalty.^''  When  the  due  date  for  a  return  falls  on  a 
Sunday  or  a  legal  holiday,  the  last  due  date  will  be 
held  to  be  the  day  next  following,  and  the  return  may 
be  filed  not  later  than  such  following  day  without 
penalty.^^ 

^  Mailing  Returns.  If  a  return  is  made  and  placed  in 
the  United  States  mails,  properly  addressed,  and  postage 
paid,  in  ample  time,  in  the  due  course  of  the  mails,  to 
reach  the  office  of  the  collector  or  deputy  collector,  on 
or  before  the  last  due  date,  no  penalty  is  held  to  attach 
should  the  return  not  be  actually  received  until  a  subse- 
quent date.^* 

Extension  of  Time  by  Collectors.  Collectors,  being 
satisfied  as  to  the  merits  of  the  claim,  and  in  the  reason- 
able exercise  of  their  judgment  and  discretion,  have 
authority  to  grant  an  extension  of  time  not  to  exceed 
thirty  days  in  the  case  of  ' '  sickness  or  absence. "  ^*  In 
the  case  of  corporations,  the  sickness  or  absence  must 

U  T.  D.  2001. 

12  Reg.  33,  Art.  175. 

13  Reg.  33,  Art.  176. 
14R€g.  33,  Art.  174. 

16  R.  S.  §3176;  Reg.  33,  Art.  17;   T.  D.  1950. 


RETURN   OP   ANNUAL  NET   INCOME  387 

be    of    an    officer    whose    signature    to    the    return    is 
required.*® 

Extension  of  Time  by  Commissioner.  In  addition  to 
the  limited  extension  ot"  thirty  days,  which  may  be 
granted  by  collectors,  the  Commissioner  of  Internal 
Revenue  has  authority  to  grant  a  reasonable  extension 
of  time  in  meritorious  cases  for  filing  returns  of  income 
by  persons,  residing  or  traveling  abroad,  who  are  unable 
to  file  the  returns  on  or  before  March  1st,*''  The  Com- 
missioner of  Internal  Revenue  also  has  authority  in  the 
case  of  either  corporations  or  individuals  to  grant  a  rea- 
sonable extension  of  time  in  meritorious  cases,  as  he  may 
deem  proper,  for  any  reason  whatever.*' 

Application  for  Extension  of  Time.  A  written  appli- 
cation for  an  extension  of  time  should  be  made  by  the 
individual  to  the  collector  or  the  Commissioner  within 
the  period  for  which  the  extension  is  desired.*®  The 
application  need  not  be  made  prior  to  the  primary  due 
date,  but  may  be  made  at  any  time  within  the  period 
for  which  extens^n  is  desired,  not  to  exceed  thirty  days 
after  the  primary  due  date  when  application  is  made  to 
collectors,*' 

Tentative  Returns.  Prior  to  the  passage  of  the  1916 
Law,  extension  of  time  could  be  granted  only  in  case 
of  sickness  or  absence,  but  the  Treasury  Department 
permitted  foreign  corporations,  and  domestic  corpora- 
tions doing  business  in  foreign  countries,  who  were  un- 

WReg.  33,  Art.  173. 

n  Act  of  September  8,  1916,  §  8  (b). 

1»  Act  of  September  8,  1916,  9  14  (c). 

l»Reg.  33,  Art.  23. 

WReg.  33,  Art.  173. 


388  FEDERAL  INCOME   TAX 

able  to  assemble  their  data  in  time  to  make  their  returns 
of  annual  net  income  on  or  before  the  primary  due  date, 
to  file  tentative  returns  approximating  as  nearly  as  pos- 
sible the  actual  business  transacted  during  the  year. 
Such  tentative  returns,  were  accepted  subject  to  the 
substitution  later  of  true  and  correct  returns,  when  the 
necessary  data  to  make  the  same  had  been  received.^^ 
Under  the  1916  Law,  the  Commissioner  of  Internal 
Revenue  has  authority  to  grant  unlimited  extension  in 
meritorious  eases,  thus  making  unnecessary  the  filing  of 
tentative  returns.'*'* 

Forms.  The  law  authorizes  the  Commissioner  of  In- 
ternal Revenue,  with  the  approval  of  the  Secretary  of 
the  Treasury,  to  prescribe  the  form  on  which  the  returns 
shall  be  made.  The  forms  have  been  changed  from  time 
to  time,  and  those  for  1917  will  contain  much  new 
matter.  The  same  form  is  prescribed  for  citizens,  resi- 
dents, and  non-resident  aliens,  whether  or  not  executed 
by  the  principal  or  by  an  agent  on  his  behalf.  Separate 
forms  are  prepared  for  use  by  fiduciwies,  and  corpora- 
tions.   The  form  for  use  by  individuals  is  known  as  Form 

1040.  The  form  for  use  by  fiduciaries  is  known  a.s  Form 

1041.  The  forms  for  use  by  corporations  are :  Form 
1030  for  insurance  companies  (including  mutual  life  and 
mutual  marine;)  Form  1030a  for  mutual  insurance  com- 
panies (other  than  mutual  life  and  mutual  marine;) 
Form  1090  for  railroad  corporations,  and  Form  1031 
for  all  other  corporations.  Forms  are  usually  sent  to 
taxpayers,  but  failure  to  receive  a  form  is  no  excuse 
for  not  making  the  return.^ 

21  T.  D.  2137. 

22  See  T.  D.  2561  and  T.  D.  2581. 
83Eeg.  33,  Art.  163. 


RETURN   OP   ANNUAL  NET   INCOME  389 

Verification  of  Returns.  The  annual  return  must 
he  verified  by  the  oath  of  the  person  making  the  same. 
The  affidavit  may  be  made  before  the  collector  of  the 
district  or  before  any  officer  authorized  by  law  to  admin- 
ister oaths.**  Revenue  agents,  inspectors  and  special 
employees,**  or  any  clerk  in  the  office  of  the  collector,** 
may,  if  commissioned  as  deputy  collectors,  take  the  oath 
of  taxpayers.  If  a  return  is  executed  before  a  notary 
in  a  state  where  the  law  does  not  require  the  notary  to 
use  a  seal,  and  none  is  used,  a  certificate  of  a  clerk  of 
court  or  other  officer  possessing  a  seal,  showing  that 
he  is  duly  commissioned  and  authorized  to  administer 
oaths,  should  be  filed  with  the  Commissioner;  otherwise 
the  return  will  not  be  accepted,*'  unless,  as  may  be  done, 
the  collector  waives  this  requirement  in  ertates  where 
jurats  are  accepted  in  the  state  courts  either  with  or 
without  a  seal,  and  without  certificate  showing  author- 
ity.«» 

Verification  Abroad.  An  individual  residing  abroad 
may  acknowledge  his  return  before  any  duly  appointed 
officer  of  the  country  in  which  he  resides,  authorized 
to  ad  mi  ulster  oaths  and  use  an  official  seal.*® 

Verification  in  Army  and  Navy.  Any  officer  in  the 
Naval  or  ^lilitary  service  of  the  United  States,  within 
or  w  ithout  the  United  States,  who  is  authorized  to  ad- 
minister oaths  for  the  purpose  of  Military  justice  and 

24  Reg.  33,  Art.  22. 

26  T.  D.  2235,  T.  D.  2238. 

26  T.  D.  2293. 

27  T.  D.  2090. 
88  T.  D.  2174. 
29  T.  D.  2090. 


390  FEDERAL   INCOME   TAX 

administration  or  Naval  justice  and  administration,  may- 
take  the  acknowledgments  of  persons  in  the  Naval  and 
Military  services.^*      # 

Assistance  of  Collectors.  Any  assistance  or  infor- 
mation, which  may  be  needed  in  connection  with  the 
preparing  and  filing  of  income  tax  returns,  is  required 
to  be  furnished  by  the  collector  upon  request.  Questions 
regarding  the  tax  will  be  answered  upon  inquiry  at  the 
Internal  Revenue  offices.  When  questions  are  directed 
to  the  Treasury  Department  at  Washington  asking  for 
information  which  should  be  supplied  by  collectors,  the 
letters  are  referred  to  the  collectors  for  reply  and 
the  writers  are  advised  accordingly .^^ 

Return  Made  by  Collector.  If  the  taxpayer  fails  to 
file  a  return  as  required  by  law,  but  consents  to  disclose 
the  particulars  of  his  income,  it  is  the  duty  of  the  col- 
lector or  deputy  collector  to  make  the  return,  which, 
being  distinctly  read  and  consented  to,  signed,  and  veri- 
fied by  the  taxpayer,  may  be  received  as  th£  return  of 
the  taxpayer.^^  If  the  taxpayer  neglects  or  refuses  to 
make  the  return,  or  makes  a  wilfully  false  or  fraudulent 
return,  it  is  the  duty  of  the  collector,  after  due  notice, 
to  make  the  return  according  to  the  best  information  he 
can  obtain  by  the  examination  of  such  person,  or  any 
other  evidence.  When  duly  certified  by  the  collector, 
such  return  is  treated  as  the  return  of  the  taxpayer 
and  the  tax  and  penalty  are  assessed  thereon.^^ 

29a  T.  D.  2534. 

30  T.  D.  1949,  T.  D.  1956. 

31  Eeg.  33,  Art.  20. 

32Eeg.  33,  Art.  21.  ' 


RETURN  OP  ANNUAL  NET   INCOME  391 

Erroneous  Returns.  If  a  return  is  improperly  pre- 
pared, it  is  returned  by  the  collector  to  the  taxpayer 
for  correction,  and  the  corrected  return  is  accepted  with- 
out penalty,  provided  the  incorrect  return  showing  the 
date  of  its  receipt  accompanies  the  corrected,  return.*' 

Amended  Returns.  Where  upon  an  audit  of  a  return 
of  an  individual,  a  fiduciary,  or  a  withholding  agent, 
or  as  a  result  of  an  investigation  made  by  a  revenue 
agent,  an  additional  tax  is  assessed,  it  is  not  necessary  to 
file  an  amended  return.  Notice  of  the  additional  assess- 
ment will  be  given  to  the  taxpayer  by  letter  from  the 
Treasury  Department.'*  Where  a  corporation  is  called 
upon  by  a  revenue  inspector  to  make  amended  returns, 
the  officers  of  the  corporation  will  be  given  the  fullest 
opportunity  to  make  any  investigation  they  may  desire 
prior  to  signing  such  amended  returns,  provided,  of 
course,  such  investigation  does  not  cover  an  unreason- 
able length  of  time.'*  In  1915  and  1916  it  was  the 
practice  of  the  Treasury  Department  to  send  out  a  letter 
to  corporations  whenever  items  on  the  return  were 
reached,  concerning  which  more  detailed  information 
was  sought,  referring  to  the  return  and  briefly  request- 
ing information  regarding  one  or  more  items  therein. 
The  letter  ended  with  a  statement  that  in  the  absence 
of  an  explanatory  affidavit,  at  the  end  of  thirty  days 
from  the  date  of  the  letter,  the  entire  amount  of  the 

83  Mimeograph  lett<?r  No.  1160  to  Collectors. 
34  Mimeograph  letter  No.  1232  to  Collectors. 
36  Letter  from  Treasury  Department  dated  February  2,   1915; 
T.  T.  S.  1917,  K  1618. 


392  PEDEBAL  INCOME  TAX 

deductions  questioned  would  be  suspended  and  an  assess- 
ment returned  accordingly.^* 

Notice  of  Failure  to  File  Returns.  When  the  col- 
lector possesses  any  information  which  leads  him  to 
believe  that  any  person  in  his  district  was  in  receipt  of 
income  for  the  year  and  did  not  make  a  return,  he  is 
required  to  serve  a  notice  calling  attention  to  the  failure 
and  to  the  fact  that  penalties  for  failure  have  been 
incurred.  The  notice  also  calls  attention  to  the  fact 
that  if  the  return  is  not  filed,  within  ten  days  from 
the  date  thereof,  the  books  and  papers  of  the  taxpayer 
will  be  examined  and  a  return  prepared  therefrom  as 
provided  by  law.*'' 

Inspection  of  Returns  by  the  Public.  The  income  tax 
law  is  specific  and  mandatory  in  the  matter  of  safe- 
guarding from  publicity  the  information  acquired  by 
reason  of  its  requirements  relative  to  annual  returns 
of  income.  The  law  imposes  on  employees  of  the  Gov- 
ernment a  penalty  of  fine,  imprisonment,  dismissal  from 
office  and  forfeiture  of  right  to  hold  office,  for  making 
known  in  any  manner  not  provided  by  the  law,  the 
amount  or  source  of  income,  or  any  particulars  thereof, 
set  forth  or  disclosed  in  an  income  return  by  any  person. 
All  internal  revenue  officers  are  cautioned  to  preserve 
as  confidential  all  income  tax  returns.**     The  returns 

36  I.  T.  S.  1917,  H  1623. 

37Eeg.  33,  Art.  196.  This  notice  is  sent  out  on  rorni  1045. 
For  the  first  year  of  the  income  tax,  March  1  to  December  31, 
1913,  the  collector  sent  out  an  informal  letter  as  a  preliminary 
to  the  formal  notice.  This  letter  invited  the  taxpayer  to  make 
a  return  without  penalty  within  ten  days  but  the  letter  was  not 
used  in  subsequent  years. 

88  T.  D.  2135,  T.  D.  1962. 


RETURN   OP   ANNUAL  NET   INCOME  393 

Oil  which  assessments  have  been  made  are  filed  in  the 
office  of  the  Commissioner  of  Internal  Revenue  and  con- 
stitute public  records  and  are  open  to  inspection  as 
such,  but  only  upon  order  of  the  President  and  under 
rules  and  regulations  prescribed  by  the  Secretary  of 
the  Treasury  and  approved  by  the  President.^®  It  was 
held  that  a  similar  provision  of  the  1909  Law  permitting 
the  inspection  of  returns  was  not  unconstitutional.** 
Under  date  of  July  28,  1914,  the  President  issued  an 
executive  order,  that  returns  should  be  subject  to  inspec- 
tion in  accordance  with  certain  rules  and  regulations 
prescribed  by  the  Secretary  of  the  Treasury  of  the 
same  date. 

Returns  Must  Be  Inspected  at  Washington.  Re- 
turns can  be  inspected  by  the  public  only  in  the  office 
of  the  Commissioner  of  Internal  Revenue  in  Washington. 
No  collector  or  any  other  internal  revenue  officer  outside 
of  the  Treasury  Department  in  Washington  is  author- 
ized to  permit  the  inspection  of  any  return,  or  to  fur- 
nish any  information  whatsoever  relative  to  any  return 
or  any  information  secured  by  him  in  his  official  capacity 
relating  to  such  return.  No  provision  is  made  in  the 
law  for  furnishing  a  copy  of  any  return  to  any  person 
or  corporation  and  no  copy  will  be  furnished  to  any 
other  than  the  person  or  corporation  making  the  return, 
or  their  duly  constituted  attorney,  except  in  the  case 
where  copies  are  furnished  to  officers  of  the  Department 
of  Justice  for  use  in  suits.*^ 

Returns  op  Individuals.  Returns  of  individuals  are 
not  c^en  to  the  inspection  of  any  person  other  than  the 

«»  Act  of  September  8,  1916,  8  14  (b). 

40  Flint  V.  Stone  Tracy  Co.,  220  U.  S.  107. 

41  T.  D.  2016. 


394  FEDERAL   INCOME  TAX 

proper  officers  and  employees  of  the  Treasury  Depart- 
ment, the  person  who  made  the  return  or  his  duly 
authorized  attorney,  and  are  under  no  conditions  made 
public,  except  where  such  publicity  results  through  the 
use  of  such  returns  in  any  legal  proceeding  in  which 
the  United  States  is  a  party.** 

Returns  op  Corporations.  The  Secretary  of  the 
Treasury,  at  his  discretion,  upon  application  to  him, 
setting  forth  what  constitutes  a  proper  showing  of  cause, 
may  permit  the  inspection  of  the  return  of  any  corpo- 
ration by  any  hana  fide  stockholder  thereof.  Application 
for  such  inspection  must  be  made  in  writing  to  the  Sec- 
retary of  the  Treasury,  setting  forth  the  reasons  why 
inspection  should  be  permitted.  Attached  to  the  applica- 
tion should  be  a  certificate  signed  by  the  president  or 
other  principal  accounting  officer  of  such  corporation, 
countersigned  by  the  secretary,  under  the  corporate  seal 
of  the  company,  that  the  applicant  ls  a  hana  fide  stock- 
holder in  the  company.  Where  such  certificate  cannot 
be  secured,  other  evidence  will  be  considered  to  deter- 
mine the  fact  whether  or  not  the  applicant  is  a  bona  fide 
stockholder.  Upon  receipt  of  such  application  the  cor- 
poration, whose  return  it  is  desired  to  inspect,  is  notified 
of  the  facts  and  given  opportunity  to  state  whether 
any  legitimate  reason  exists  for  refusing  permission. 
The  privilege  of  inspecting  the  return  of  any  corpora- 
tion is  personal  to  the  stockholders,  and  the  permission 
granted  by  the  Secretary  of  the  Treasury  to  make  such 
inspection  cannot  be  delegated  tb  any  other  person.*' 
A  person  who,  as  trustee  or  in  any  other  fiduciary  rela- 
tion, has  the  ownership  or  possessory  right  to  stock  in 


42  T.  D.  2016. 
«  T.  D.  2016. 


i 


BETURN   OP  ANNUAL  NET   INCOME  395 

a  corporation,  is  considered  as  a  stockholder  in  such 
corporation.**  Copies  of  returns  on  file  in  the  Com- 
missioner's office  are  not  permitted  to  be  sent  to  any 
person,  except  the  corporation  itself,  or  its  duly  author- 
ized attorney,  and  in  no  case  may  the  original  returns 
be  removed  except  upon  order  and  by  direction  of  the 
Secretary  of  the  Treasury  or  the  President.** 

CoRPOR^VTiONS  Which  Offer  Their  Stock  to  the 
Public  fob  Sale.  The  returns  of  all  corporations, 
whose  stock  is  advertised  in  the  press  or  offered  for 
sale  to  the  public  by  the  corporation  itself,  may  be 
inspected  by  any  person  upon  written  application  to 
the  Secretary  of  the  Treasury,  which  application  shall 
set  forth  briefly  and  succinctly  all  facts  necessary  to 
enable  the  Secretary  to  act  upon  the,  request.  In  case 
of  doubt  as  to  whether  any  company  falls  within  this 
classification,  the  person  desiring  to  see  such  return 
should  support  his  application  by  advertisements,  pro- 
spectus or  such  other  evidence  as  he  may  deem  proper 
to  establish  the  fact  that  the  stock  of  the  corporation 
is  offered  for  general  public  sale.** 

Corporations  Whose  Stock  Is  Listed  on  a  Stock 
Exchange.  The  returns  of  all  companies  whose  stock 
is  listed  upon  any  duly  organized  and  recognized  stock 
exchange  within  the  United  States,  for  the  purpose  of 
having  its  shares  dealt  in  by  the  public  generally,  are 
open  to  the  inspection  of  any  person  upon  written 
application  to  the  Secretary  of  the  Treasury,  which  appli- 
cation shall  set  forth  briefly  and  succinctly  all  facts 

4*  Op.  At^.  Gen.  Dec.  27,  1910. 
«  Reg.  33,  Arta.  178  and  179. 
««T.  D.  2016. 


396  FEDERAL   INCOME  TAX 

necessary    to    enable  the    Secretary    to    act    upon    the 
request.*'' 

Inspection  of  Returns  by  State  Officers.  The  proper 
officers  of  any  state,  imposing  a  general  income  tax, 
may  on  request  of  the  Governor  thereof  have  access  to 
the  returns  of  corporations,  or  to  the  abstracts  of  such 
returns  showing  the  name  and  income  of  each  corpora- 
tion, at  such  times  and  in  such  manner  as  the  Secretary 
of  the  Treasury  may  prescribe.  A  request  for  such 
inspection  must  be  signed  by  the  Governor  of  the  state 
and  sealed  with  the  seal  of  the  state  and  transmitted 
to  the  Secretary  of  the  Treasury  for  his  consideration 
and  action  thereon.** 

Inspection  of  Returns  by  Government  Officers.  Re- 
turns of  corporations  (but  not  of  individuals)  may  be 
inspected  by  an  officer  or  employee  of  any  department 
of  the  Government,  on  application  to  the  Secretary  of 
the  Treasury  by  the  head  of  the  executive  department 
in  which  such  officer  or  employee  is  employed.  If  the 
return  of  a  corporation  is  desired  to  be  used  in  any 
legal  proceedings  other  than  those  to  which  the  United 
States  is  a  party,  or  to  be  used  in  a  manner  by  which 
any  information  contained  in  the  return  could  be  made 
public,  the  application  for  permission  to  inspect  the 
return,  or  to  furnish  a  certified  copy,  must  be  referred 

47  T.  D.  2016. 

48  T.  D.  2016.  It  is  to  be  noted  that  the  law  permits  inspec- 
tion only  by  officers  of  states  which  have  a  general  inoome  tax. 
This  may  not  necessarily  mean  a  tax  on  both  corporations  and 
individuals,  but  the  privilege  to  inspect  returns  applies  only  to 
the  returns  of  corporations. 


RETURN   OP   ANNUAL  NET   INCOME  397 

to  the  Attorney  General  for  his  recommendation  before 
transmission  to  the  Secretary  of  the  Treasury.*® 

For  Use  in  Government  Suits.  All  returns  whether 
of  persons  or  of  corporations  may  be  furnished,  upon 
approval  of  the  Secretary  of  the  Treasury,  for»use  in 
any  legal  proceedings  before  any  United  States  grand 
jury  or  in  the  trial  of  any  cause  to  which  both  the 
United  States  and  the  person  or  corporation  rendering 
the  return  are  parties,  provided  the  return  would  con- 
stitute material  evidence  in  the  prosecution,  defense  or 
trial  of  such  action  or  proceeding.  In  any  case  arising 
in  the  collection  of  the  income  tax  the  Commissioner 
of  Internal  Revenue  may  furnish  for  the  use  of  the 
proper  oflScer  either  the  original  or  certified  copies  of 
returns,  without  the  approval  of  the  Secretary  of  the 
Treasury.*® 

«T.  D.  2016. 

WT.  D.  2016;   Reg.  33,  Art.  180. 


CHAPTER  36 

ASSESSMENT  AND  PAYMENT  OF  THE   TAX 

All  assessments  are  made  by  the  Commissioner  of  In- 
ternal Revenue.^  After  the  return  of  annual  net  in- 
come has  been  filed  with  the  collector,  it  is  sent  to  the 
Treasury  Department  at  Washington  for  assessment  of 
the  tax.  When  the  assessment  has  been  made,  the  amount 
thereof  is  reported  to  the  local  collector  who  notifies  the 
taxpayer,  on  or  before  June  1st,  of  the  amount  thereof. 
The  tax  becomes  due  on  the  15th  day  of  June,  but  an 
additional  period  of  grace,  being  at  least  ten  days  after 
June  15,  is  allowed  before  penalty  or  interest  applies. 
In  the  case  of  corporations  reporting  for  their  fiscal 
years  the  return  of  net  income,  when  filed,  is  immediately 
forwarded  to  the  Treasury  Department  at  Washington 
and  the  tax  assessed  thereon.  The  amount  thereof  is 
reported  to  the  local  collector  who  notifies  the  corpora- 
tion and  payment  is  due  105  days  from  the  date  on 
which  the  return  of  income  is  required  to  be  made  in 
such  cases,  and  after  ten  days  notice  and  demand  by  the 
collector.'*  If  the  tax  is  not  paid  within  ten  days  after 
notice  and  demand  by  the  collector,  which  notice  can- 
not be  given  before  the  15th  day  of  June  or  before  the 
expiration  of  165  days  after  the  close  of  the  fiscal  year 
of  a  corporation  reporting  on  the  basis  of  its  fiscal  year, 

1  Act  of  September  8,  1916,  §  9  (a)  and  §  14  (a). 

2  Act  of  September  8,  1916,  §  14  (a). 

398 


ASSESSMENT   AND   PAYMENT   OP  THE  TAX  399 

l)enalty  and  interest  accrue.  The  Government  may  pro- 
ceed by  levying  on  and  distraining  the  property  of  the 
taxpayer  if  payment  of  penalty  and  interest  is  not  made 
within  ten  days  from  the  date  of  the  second  notice  and 
demand  for  the  tax.  This  drastic  mean«  of  enforcing 
payment  is  within  the  power  of  Congress  since  the  power 
to  tax  includes  the  power  to  undertake  effectual  means 
to  collect  (he  tax.' 

Suit  to  Restrain  Assessment  or  Collection.  No  suit 
for  the  purpose  of  restraining  the  assessment  or  collec- 
tion of  any  tax  shall  be  maintained  in  any  court.*  The 
constitutionality  of  a  law  cannot  be  inquired  into  in  an 
injunction  suit  against  the  government,*  but  may  be  in  a 
stockholder's  suit  to  enjoin  the  corporation  from  volun- 
tarily paying  a  tax  charged  to  l)e  unconstitutional.®  An 
injunction  will  not  be  granted  at  the  instance  of  a  stock- 
holder to  restrain  the  officers  of  a  corporation  from  pay- 
ing the  tax,  other  than  voluntarily,  as  that  would,  in 
effect,  be  the  same  as  an  action  to  restrain  the  Govern- 
ment.'' Allegations  that  an  a8.sessment  is  irregular  and 
void  do  not  constitute  any  ground  for  an  injunction.*  A 
bill  in  equity  will  not  lie  to  enjoin  collection  although  the 

SMcCuUoch  V.  Maryland,  4  Wheat.  316;  Flint  v.  Btone-Tracy 
Co.,  220  U.  S.  107. 

«B.  S.,  §3224. 

» Delaware  R.  R.  Co.  v.  Prettyman,  17  Int.  Rev.  Rec.  99;  Allen 
V.  Pullman 's  Palace  Car  Co.,  139  U.  S.  658 ;  Dodge  v.  Brady,  240 
I'.  8.  122. 

6  Pollock  V.  Farmers  Loan  &  Trust  Co.,  157  U.  8.  429;  Flint 
V.  8tone-Tracy  Co.,  220  U.  S.  107;  Brushaber  v.  Union  Pacific 
K.  R.  Co.,  240  U.  8.  1. 

^  Strauss  v.  Abrast  Realty  Co.,  200  Fed.  ?27. 

>  Alkan  v.  Bean,  23  Int  Rev.  Rec.  351. 


400  FEDERAL   INCOME  TAX 

tax  is  alleged  in  the  bill  to  have  been  illegally  assessed.^ 
A  collector  cannot  be  restrained  from  collecting  an  assess- 
ment by  hi j unction,  1®  It  is  contrary  to  every  principle 
of  equity  jurisprudence  that  the  collection  of  taxes  on 
personal  property  should  be  stayed  by  injunction.^^  The 
courts  will  not  interfere  by  a  mandamus  with  the  execu-. 
tive  officers  of  the  Government  in  the  exercise  of  their 
ordinary  official  duties.^*  In  matters  which  require  an 
executive  officer  to  exercise  judgment  or  discretion  no 
rule  will  issue  for  mandamus.^^  The  inhibition  of  Sec- 
tion 3224  applies  to  all  assessments  of  taxes,  made  under 
color  of  their  offices,  by  internal  revenue  officers  charged 
with  general  jurisdiction  of  the  subject  of  assessing  the 
income  tax.  The  remedy  of  a  suit  to  recover  back  the  tax 
after  it  is  paid  is  provided  by  statute,  and  a  suit  to  re- 
strain its  collection  is  forbidden.  The  remedy  so  given 
is  exclusive,  and  no  other  remedy  can  be  substituted  for 
it.  The  system  of  administrative  measures,  not  judicial, 
to  collect  internal  revenue  taxes,  with  appeals  to  speci- 
fied tribunals,  and  suits  to  recover  back  moneys  illegally 
exacted  is  a  system  of  corrective  justice  intended  to  be 
complete,  and  enacted  under  the  right  belonging  to  the 
Government  to  prescribe  the  conditions  on  which  it  would 

9  Snyder  v.  Marks,  lOg  U.  S.  189;  Dodge  v,  Osborn,  240  U,  S, 
118, 

10  State  R.  R.  Tax  cases,  92  U.  S.  575;  Keely  v.  Sanders,  99  U.  S, 
441, 

11  Nye  V,  Washburn,  125  Fed.  818, 

12  U,  S.  V,  Black,  128  U.  S,  40,  The  court  in  this  case  followed 
an  earlier  decision  of  Decatur  v.  Paulding  (14  Pet,  497)  and  made 
clear  the  distinction  between  the  mere  ministerial  act  of  the  exec- 
utive officer,  which  may  be  controlled  by  the  courts  by  mandamus, 
and  an  act  in  the  performance  of  which  an  officer  is  vested  with 
quasi-judicial  discretion. 

13  Carrick  v,  Lamar,  116  U,  S.  423. 


ASSESSMENT    AND   PAYMENT  OP  THE  TAX  401 

subject  itself  to  the  judgment  of  the  courts  in  the  collec- 
tion of  its  revenues.^* 

Notice  of  Assessment.  When  the  assessment  has  been 
made  by  the  Commissioner  of  Internal  Revenue  the  col- 
lector is  notified  and  he  sends  the^xpaycr  a  notice  of 
assessment,  usually  on  or  before  June  1.**  This  notice, 
however,  is  not  a  demand  for  payment  of  the  tax,  but 
is  merely  a  notification  of  the  amount  which  has  been 
assessed  and  the  date  on  which  the  tax  is  due  and  paj'- 
able.  Failure  to  pay  the  tax  on  receipt  of  this  notice 
does  not  make  the  taxpayer  liable  for  penalty  or  interest. 
In  the  case  of  a  corporation  making  returns  for  a  fiscal 
year,  the  notice  of  assessment  is  given  on  or  before  the 
expiration  of  ninety  days  from  the  day  when  the  return 
was  required  to  be  filed.*® 

Notice  ajid  Demand  for  Tax.  If  the  tax  is  not  paid 
on  or  before  the  date  on  which  it  is  due,  a  notice  and 
demand  is  issued  to  the  taxpayer.  The  notice  and  de- 
mand is  usually  dated  and  sent  out  on  the  day  the  tax 
is  due.  It  calls  attention  to  the  fact  that  the  tax  has 
been  assessed,  .showing  the  amount  thereof,  and  demands 
payment  on  or  before  a  date  given  in  the  notice.    Unless 

14  Dodge  V.  Osborn,  240  U.  3.  118. 

16  The  notice  is  given  to  corporations  on  a  form  known  as  Form 
1-647A  and  to  individuals  on  Form  1-647B.  The  two  forms  are 
essentially  the  same.  Each  is  divided  into  three  parts,  one  part 
for  the  taxpayer  (which  will  operate  as  his  receipt  when  he  pays 
the  tax),  one  part  for  the  record  of  the  Commissioner,  and  one 
part  for  the  record  of  the  local  collector.  When  the  tax  is  paid 
all  three  parts  of  the  notice  should  be  presented  to  the  local  col- 
lector who  will  properly  receipt  the  part  intended  for  the  taxpayer 
and  retain  the  other  two  parts. 

16  Reg.  33,  Art.  177. 
F.  I.  Tax.— 26 


402  FEDER^VL   INCOME  TAX 

the  tax  is  paid  within  the  time  specified  the  penalty  im- 
posed for  delay  in  payment  of  the  tax  will  be  added  to 
the  assessment.^''^  This  notice  and  demand  is  necessary 
in  order  to  make  the  taxpayer  liable  for  the  penalty  and 
interest  in  case  of  delay  in  payment  of  the  tax,  and  is 
necessary  to  complete  the  government's  lien  on  property 
belonging  to  the  taxpayer.  The  fact  that  a  claim  for 
abatement  is  pending,  or  the  tax  is  in  litigation,  does 
not  relieve  the  collector  from  issuing  the  notice.^*  The 
notice  may  lawfully  he  given  by  mail  and  when  so  given 
is  presumed  to  have  been  received.  The  burden  rests 
,  on  the  taxpayer  to  prove  the  contrary  in  order  to  avoid 
the  penalty.^^  The  practice  of  the  Department  in  such 
cases  is  to  permit  the  taxpayer  to  show,  to  the  satisfac- 
tion of  the  Commissioner,  that  he  did  not  receive  the 
notice,  and  upon  such  showing  to  give  the  taxpayer  an 
opportunity  to  pay  his  taxes  without  penalty.  The  record 
of  the  collector  showing  that  notice  had  been  duly  mailed 
is  considered  merely  as  prima  facie  evidence  that  the 
notice  was  received.'*'*  The  date  appearing  on  the  notice 
and  demand,  as  the  last  date  on  which  the  tax  may  be 
paid  without  penalty,  should  be  a  date  ten  days  subse- 
quent to  the  actual  mailing  of  the  notice  and  not  neces- 
sarily ten  days  from  the  date  of  the  notice.  The  date  of 
mailing  controls.^^ 

17  Eeg.  33.  Art.  197.  Form  1-17A  is  used  in  notifying  corpo- 
rations and  Form  1-17B  in  notifying  individuals.  The  forms  are 
essentially  the  same,  each  is  divided  in  three  parts  in  the  niannei* 
and  for  the  purpose  described  in  the  preceding  note  regarding 
the  notice  of  assessment. 

18  T.  D.  1995. 

19  U.  S.  V.  General  Inspection  and  Loading  Company,  204  Fed. 
657. 

201.  T.  S.  1917,  1[2268. 
21  T.  D.  1659. 


ASSESSMENT   AND   PAYMENT  OP   THE  TAX  403 

Notice  and  Demand  to  Absentees.  When  an  indi- 
vidual is  absent  in  a  foreign  country  and  it  is  impossible 
for  him  to  receive  the  notice  and  demand  in  time  to  make 
payment  of  the  taxes  assessed  thereon  within  the  ten-day 
period  following  the  service  of  the  notice,  the  collector 
will  make  an  allowance  so  that  the  tax  may  be  paid  with- 
out penalty  ten  days  after  receipt  of  the  notice,  and,  if 
the  full  amount  of  the  tax  has  been  placed  in  the  mail 
for  transmission  within  ten  days  after  such  receipt,  the 
penalty  and  interest  will  not  be  exacted.  In  such  a 
ease  the  envelope  which  enclosed  the  notice,  bearing 
the  postmark  of  the  receiving  office,  should,  if  possible, 
be  forwarded  to  the  collector  as  evidence  of  the  cause 
of  delay.  This  ruling  applies  only  to  the  collection  of  the 
tax  from  individuals,**  but  it  would  seem  to  be  a  rea- 
sonable rule  to  apply  to  all  cases  where  the  time  consumed 
in  the  transmission  of  the  mails  makes  it  impossible  to 
mail  the  notice  and  demand  and  to  receive  reply  in  ten 
days. 

Second  Notice  and  Demand  for  Tax.  If  the  tax  is 
not  paid  within  ten  days  after  mailing  the  first  notice 
and  demand,  a  second  notice  and  demand  is  given  the 
taxpayer,  which  states  that  having  failed  to  make  pay- 
ment of  the  tax  within  the  prescribed  time  after  notice 
and  demand,  there  has  attached  a  5%  penalty  on  the 
tax  and  interest  at  1%  per  month  from  a  specified 
date.  In  this  notice,  demand  is  made  for  the  taxes,  pen- 
alty and  such  interest  as  may  accrue  before  payment, 
together  with  a  threat  that  if  the  tax,  penalty  and  inter- 
est is  not  paid  within  ten  days  from  the  date  of  the 
notice,  the  Collector  of  Internal  Revenue  will  collect 
the  same  with  costs  by  seizure  and  sale  of  property.** 

MT.  D.  2028. 

Si<Form  1-21A  is  used  in  giving  corporations  the  second  notice 
and  demand  for  tax  and  Form  1-21B  is  used  in  notifying  in- 


404  FEDERAL   INCOME  TAX 

Time  of  Payment  of  Tax.  The  primary  due  date  is 
June  15th,  or  in  the  case  of  corporations  reporting  for 
their  fiscal  years  the  165th  day  after  the  close  of  their 
fiscal  years.  In  the  case  of  corporations  care  should  be 
taken  to  reckon  the  days  correctly,  as  165  days  is  not  - 
equivalent  to  five  and  one-half  months.  The  second  due 
date  is  the  date  given  on  the  notice  and  demand  for  tax, 
which  date  should  be  not  less  than  ten  days  after  the 
first  due  date.  The  second  due  date  is  the  last  day  on 
which  the  tax  may  be  paid  without  penalty  or  interest. 
The  payment  of  the  tax  may  be  made  at  any  time  during 
the  last  day.  To  accommodate  those  who  make  payments 
after  closing  time  a  mail  box  is  provided  at  the  cashier's 
window  in  the  office  of  the  local  collector  for  the  deposit 
of  such  collections.^* 

Advance  Payment  of  Tax.  The  Secretary  of  the 
Treasury,  under  rules  and  regulations  prescribed  by  him, 
is  required  to  permit  taxpayers  liable  to  income  taxes 
to  make  payments  in  advance  in  instalments,  or  in 
whole,  of  an  amount  not  in  excess  of  the  estimated  taxes 
which  will  be  due  from  them,  and  upon  determination 
of  the  taxes  actually  due  any  amount  paid  in  excess 
shall  be  refunded  as  taxes  erroneously  collected.  When 
payment  is  made  in  instalments,  the  law  requires  at  least 
one-fourth  of  such  estimated  tax  to  be  paid  before  the 
expiration  of  thirty  days  after  the  close  of  the  taxable 
year,  at  least  an  additional  one-fourth  within  two  months 
after  the  close  of  the  taxable  year,  at  least  an  additional 
one-fourth  within  four  months  after  the  close  of  the  tax- 

dividuals.     The  forms  are  essentially  the  same,  each  is  divided 
into  three  parts  in  the  manner  and  for  the  purpose  described  in 
the  note  regarding  the  notice  of  assessment. 
24  T.  D.  1728. 


ASSESSMENT    AND   PAYMENT  OP   THE  TAX  405 

able  year,  and  the  remainder  of  the  tax  due,  on  or  before 
the  regular*  due  dates  fixed  by  law.  The  Secretary 
of  the  Treasury  may  allow  a  credit  against  taxes  so 
paid  in  advance  of  an  amount  not  exceeding  the  rate 
of  3%  per  annum,  calculated  upon  the  amounts  so  paid 
from  the  date  of  such  payment  to  the  regular  due  date 
fixed  by  law ;  but  no  such  credit  is  allowed  on  payments 
in  excess  of  taxes  determined  to  be  due,  nor  on  payments 
made  after  the  expiration  of-  four  and  one-half  months 
after  the  close  of  the  taxable  year.**  All  the  penalties 
provided  by  law  for  failure  to  pay  the  tax  when  due,  are 
applicable  to  any  failure  to  pay  the  tax  at  the  time  or 
times  above  stated,  in  case  the  taxpayer  chooses  to  pay 
in  advance.  The  purpose  of  applying  the  penalties  to 
such  advance  payments  seems  to  be  to  protect  the  tax- 
payer, who  chooses  to  make  payments  in  advance,  from 
the  legal  disability  of  recovering  voluntary  payments  of 
taxes.  By  applying  the  penalties  the  taxpayer  may,  if 
he  observes  the  rules  as  to  protest  and  duress,  pay  the 
tax  in  advance  and  thereafter  sue  to  recover  if  he  has 
overpaid  or  paid  under  an  erroneous  assessment. 

Manner  of  Payment  of  Taxes.  As  a  general  rule, 
payment  of  the  tax  is  authorized  by  law  to  be  made  in 
certified  checks  drawn  in  favor  of  the  collector  on 
national  and  state  banks  and  trust  companies  located  in 
the  city  where  the  collector  has  his  office,  and  also  such 
"out-of-town"  certified  checks  as  can  be  cashed  without 
cost  to  the  government,  providing  the  depositary  will 
accept  for  deposit  "out-of-town"  certified  checks  "with- 
out recourse."  Prior  to  this  year  the  Treasury  Depart- 
ment did  not  specifically  authorize  the  acceptance  of  any 
form  of  exchange  in  payment  of  internal  revenue  taxes, 

M  Act  of  October  3,  1917  (PubUc  No.  50),  f  1009. 


406  FEDERAL   INCOME  TAX 

other  than  currency  and  such  certified  checks  as  are 
above  described.'*^  There  was  no  objection  to  a  collec- 
tor accepting  at  his  own  risk,  or  at  the  risk  of  the  gov- 
ernment depositary,  uncertified  checks,  or  any  other 
form  of  exchange,  for  collection  only.^''^  Where  a  form 
of  remittance  not  authorized  by  law  was  accepted  for 
collection,  the  5%  penalty  was  incurred  by  the  taxpayer, 
if  there  was  delay  in  collection  and  the  funds  were  not 
actually  received  by  the  collector  within  the  time  pro- 
vided by  law.  Receipt  by  the  Government  depositary,  in 
the  course  of  collection,  was  held  not  to  be  receipt  by  the 
collector,  as  the  depositary  is  not  an  agent  of  the  col- 
lector or  of  the  government.*'  At  present  the  law  pro- 
vides that,  under  rules  and  regulations  prescribed  by 
the  Secretary  of  the  Treasury,  collectors  may  receive, 
at  par  and  accrued  interest,  certificates  of  indebtedness 
issued  under  Section  6  of  the  Act  entitled  "An  Act  to 
authorize  an  issue  of  bonds  to  meet  expenditures  for  the 
National  security  and  defense,  and,  for  the  purpose  of 
assisting  in  the  prosecution  of  the  war,  to  extend  credit 
to  foreign  governments,  and  for  other  purposes,"  ap- 
proved April  24,  1917,  and  any  subsequent  act  or  acts. 
Under  the  same  provision  of  law,  and  under  rules  and 
regulations  prescribed  by  the  Secretary  of  the  Treasury, 
collectors  may  also  receive  uncertified  checks  in  payment 
of  income  taxes,  during  such  time,  and  under  such  regu- 
lations, as  the  Commissioner  of  Internal  Revenue,  with 
the  approval  of  the  Secretary  of  the  Treasury,  shall 
prescribe;  but  if  a  check  so  received  is  not  paid  by  the 
bank  on  which  it  is  drawn,  the  person  by  whom  such 
check  has  been  tendered  shall  remain  liable  for  the  pay- 

86  T.  D.  1990. 

27  T.  D.  2158. 

28  T.  D.  1651. 


ASSESSMENT    AND    PAYMENT   OF   THE   TAX  407 

nieut  of  the  tax  and  for  all  legal  penalties  and  additions 
the  same  as  if  such  check  had  not  been  tendered.*®  If 
payment  is  made  by  check  the  taxpayer  as  a  precaution 
should  draw  the  check  for  such  amount  as  to  cover  any 
collection  charges  by  the  bank,  in  order  that  the  net 
amount  received  by  the  Government  may  be  the  full 
amount  of  tax  due. 

Payment  Under  Protest.  The  purpose  of  paying  a 
tax  under  protest  is  to  preserve  the  taxpayer's  rights  to 
recover  the  tax  should  the  assessment  prove  to  be  wrong- 
kil  or  excessive.  As  a  general  rule  of  law,  a  voluntary 
payment  of  money  cannot  be  recovered  and  this  rule  ap- 
plies to  payments  of  taxes.  It  does  not  seem  essential, 
although  it  may  be  a  wise  precaution,  also  to  protest  at 
the  time  of  filing  the  return  on  which  the  assessment  is 
based. 

Recovery  op  Taxes  prom  Commissioner  op  Internal 
Revenue.  It  would  seem  that  a  protest  is  not  neces- 
sary to  recover  taxes  from  the  Commissioner  of  Internal 
Revenue,  but  essential  if  suit  is  to  be  maintained  against 
an  adverse  decision  of  the  Commissioner.''  It  is  a 
principle  universally  recognized  that  an  action  cannot 
be  maintained  for  the  recovery  of  money  paid  in  dis- 
charge of  a  tax  illegally  assessed,  unless  the  payment 
was  made  under  protest.  But  this  principle  has  been 
held  by  the  Commissioner  of  Internal  Revenue  and 
other  officers  of  the  Department  as  too  technical  and 
too  exacting  for  application  to  the  refund  of  taxes  under 
Section  3220  of  the  Revised  Statutes.^^i 

W  Act  of  October  3,  1917  (Public  No.  50),  (  1010. 

80  Chesebrough  v.  U.  S.,  192  U.  S.  253. 

81  Real  Estate  Savings  Bank  v.  U.  8.,  16  Court  of  Claims  335; 
27  Int.  Rev.  Rec.  154. 


408  FEDERAL   INCOME  TAX 

Recovery  by  Action  at  Law.  Though  there  is  some 
conflict  in  the  dicta  of  the  Supreme  Court,  the  true  doc- 
trine seems  to  be  that  when  taxes  are  paid  under  protest 
or  with  notice  that  the  payer  contends  that  they  are 
illegal  and  intends  to  institute  a  suit  to  compel  their  re- 
payment, a  sufficient  foundation  for  suit  to  recover  has 
been  established.^^  It  appears  that  a  collector  is  not 
personally  liable  for  taxes  if  no  protest  or  objection  is 
made  to  their  collection  by  him.^^ 

Form  of  Protest.  There  seems  to  be  no  legal  require- 
ment that  a  protest  be  in  writing.  An  oral  protest  may 
be  effective,^*  but  a  written. protest  is,  of  course,  better 
evidence.  A  protest  against  paying  the  tax  includes  the 
penalties  without  specific  mention  of  the  latter.  Where 
a  corporation  had  been  assessed  for  taxes  and  the  same 
were  not  paid,  a  writ  of  distraint  was  issued  by  the 
collector,  and,  the  corporation  having  been  notified  that 
the  tax  would  be  collected  by  levy,  the  deputy  collector 
counted  out  and  took  from  a  representative  of  the  com- 
pany a  sufficient  amount  to  pay  the  tax  against  verbal 
protest  at  the  time.  A  written  notice  of  protest  was  then 
served  in  which  the  corporation  denied  that  it  was 
liable  to  the  tax.  The  court  held  that  the  protest  was 
sufficient.^^  Under  the  1909  Law  the  Treasury  Depart- 
ment ruled  that  no  form  of  protest  was  prescribed,  any 
form  of  protest  would  be  sufficient  if  filed  before  pay- 
ment of  the  tax,  and  the  right  of  protest  was  not  to  be 
denied.^^ 


32  Herold  v.  Kahn,  159  Fed.  608. 

33  Commissioners,  etc.  v.  Buckner,  48  Fed.  533. 

34  Wright  v.  Blackeslee,  101  U.  S.  174. 

36  Abrast  Eealty  Co.  v.  Maxwell,  206  Fed.  333. 
86  T.  D.  1675. 


ASSESSMENT   AND   PAYMENT  OP  THE  TAX  409 

Protest  Alone  Not  Sufficient.  The  protest  is  used 
to  give  effect  to  other  attending  circumstances.  A  pro- 
test accompanying  a  voluntary  payment  is  not  sufficient. 
There  must  be  coercion  and  duress.  The  protest  gives 
notice  that  the  payment  is  not  to  be  considered  as  ad- 
mitting the  right  to  make  the  demand,  but  if  payment  of 
the  tax  is  made  under  protest,  without  any  coercion  by 
actual  or  threatened  exercise  of  po\ver  by  the  party 
exacting  or  receiving  the  payment,  over  the  person  or 
property  of  the  party  making  the  payment,  from  which 
the  latter  has  no  other  means  of  immediate  relief  than 
such  payment,  the  payment  is  voluntary  and  cannot  be 
recovered.^"'  "Where  a  party  pays  an  illegal  demand, 
with  full  knowledge  of  all  the  facts  which  render  such 
demand  illegal,  without  an  immediate  and  urgent  neces- 
sity therefor,  or  unless  to  release  his  person  or  property 
from  detention,  or  to  prevent  an  immediate  seizure  of 
his  p«»^son  or  property,  such  payment  must  be  deemed 
voluntary."*'  The  duress  and  coercion  must  come  from 
the  Government  or  its  agents,'®  not  from  a  third  party 
and  the  protest  must  be  made  to  a  duly  authorized  agent 
of  the  Government  having  authority  to  collect  the  tax.** 

Duress.  To  recover  the  tax,  payment  must  be  made 
under  duress  and  accompanied  by  a  protest.  As  indi- 
cated in  the  preceding  paragraph  the  duress  must  come 
from  the  Government  and  be  such  as  to  create  an  imme- 
diate and  urgent  necessity  for  paying  the  tax,  in  order 
to  protect  the  person  or  property  of  the  taxpayer.  The 
oases  gontain  a  wide  discussion  of  what  constitutes  duress 

37  Chesebrough  v.  U.  8.,  192  U.  S.  253. 

>•  Railroad  Co.  v.  Commissioners,  98  U.  S.  541 ;  Little  v.  Bowers, 
134  U.  S.  547. 

39  Chesebrough  v.  U.  S.,  192  U.  8.  253. 

40  U.  8.  V,  New  York  &  Cuba  Mail  8.  8.  Co.,  200  U.  8.  488. 


410  FEDERAL   INCOME  TAX 

under  various  circumstances  and  particular  statutes.  A 
discussion  of  the  general  question  would  not  be  of  par- 
ticular value  in  this  work.  Clearly  a  payment  made 
upon  receipt  of  the  notice  of  assessment  would  not  be  a 
payment  under  duress,  since  that  notice  does  not  demand 
the  tax  and  does  not  contain  any  threat  of  penalties.  It 
seems  reasonably  certain  that  payment  after  receipt  of 
the  notice  and  denjand  for  tax  would  be  payment  under 
duress,  although  the  present  form  of  such  notice,*^  does 
not  contain  a  specific  threat  to  collect  the  penalties  but 
merely  a  statement  that  the  penalties  will  accrue  if  the 
payment  is  not  made  on  or  before  a  certain  date.  The 
form  of  notice  and  demand  in  use  prior  to  1917  con- 
tained a  direct  threat  that  the  collector  would  collect  the 
tax  with  penalty  and  interest  if  payment  was  not  made 
within  the  ten  day  limit.  In  a  case  where  a  notice  very 
similar  in  form  and  containing  such  a  threat  had  been 
served  on  a  taxpayer  under  the  War  Revenue  Act  of 
June  13,  1898,  the  court  said  in  part:  "Every  demand 
by  one  clothed  with  official  legal  authority  to  make  the 
demand,  imposes  a  certain  compulsion  on  the  one  upon 
whom  the  demand  is  made.  Such  a  demand  is  always 
exigent  and  places  the  recusant  in  a  position  of  disad- 
vantage. Especially  is  this  so  in  regard  to  payment  of 
taxes,  state  or  national.  The  proper  administration  of 
the  fiscal  affairs  of  the  Government,  require  that  the  pay- 
ment of  taxes  should  not  be  delayed  by  disputes  as  to 
their  legality,  but  that  the  taxes  should  first  be  paid 
and  all  questions  in  regard  to  them  be  determined  in 
suits  brought  for  their  refunding.  It  is  a  wise  uplicy, 
therefore,  that  encourages  the  payment  under  protest 
of  disputed  taxes.    Though  there  is  some  conflict  in  the 

41  Form  1-17.     Qompare  this  notice  with  Form  17  in  use  prior 
to  1916. 


ASSESSMENT    AND   PAYMENT   OP   THE   TAX  411 

dicta  of  the  Supreme  Court,  we  think  that  the  true 
determination  is  that,  when  taxes  are  paid  under  protest 
that  they  are  being  illegally  exacted,  or  with  notice  that 
the  payor  contends  that  they  are  illegal  and  intends  to 
institute  suit  to  compel  their  repayment,  a  sufficient 
foundation  for  such  a  suit  has  been  established.  In  the 
case  at  bar,  however,  there  was  more  than  the  simple 
payment  of  the  tax  under  protest  as  to  its  illegality,  as 
it  was  paid  upon  the  demand  of  the  Collector,  coupled 
with  a  threat  that  unless  promptly  paid,  the  same  would 
be  collected  with  a  penalty  and  interest  at  1%  per 
month.  Payment  upon  such  a  demand  from  a  govern- 
ment official,  acting  within  the  scope  of  his  authority, 
constituted  such  a  duress  as  clearly  made  such  payment 
involuntary."**  It  seems  that  the  present  form  of 
notice  and  demand  although  not  containing  an  express 
threat  to  collect  the  5%  penalty  and  interest,  but  contain- 
ing a  statement  that  such  penalty  and  interest  will  ac- 
crue, is  sufficient  duress  to  compel  involuntary  payment 
by  the  taxpayer  in  order  to  protect  himself  from  the 
penalty  and  interest.  However,  there  can  be  no  doubt 
that  payment  upon  receiving  the  second  notice  and  de- 
mand is  clearly  payment  under  duress,  .since  that  notice 
threatens  the  seizure  and  sale  of  the  taxpayer's  property 
to  satisfy  the  tax,  penalty,  interest  and  costs.*^  If  the 
taxpayer  delays  payment  until  the  receipt  of  such  notice, 
in  order  that  it  may  be  shown  that  payment  was  clearly 
made  under  dut*ess,  penalty  and  interest  must  also  be 
paid,  and  the  protest  should  be  not  only  against  payment 

Ki    *»  Herold  v.  Kahn,  159  Fed.  608;  86  C.  C.  A.  598;  citing  Chese- 
Kbrough  V.  IT.  8.,  192  U.  S.  25.3;  24  Sup.  Ct.  262,  42  L.  E»l.  4.32, 
and  City  of  Philadelphia  v.  Collector,  5  Wall.  720,  18  L.  Ed.  614. 
48  See  Form  1-21A  or  1-21B. 


412  FEDERAL   INCOME  TAX 

of  the  tax  but  against  payment  of  such  penalty  and 
interest  as  well. 

Form  of  Receipt  for  Pajrment  of  Tax.  The  only  offi- 
cial receipt  for  taxes  that  collectors  may  sign  under  the 
law  is  the  form  prescribed  by  the  Department.  How- 
ever, there  is  not  objection,  on  the  part  of  the  Depart- 
ment, to  collectors  signing  commercial  receipts  or 
voucher  checks,  but  they  should  in  signing  such  receipts 
or  vouchers  write  or  stamp  across  the  face  thereof  "not 
an  official  receipt."  The  official  receipt  must  also  be 
furnished,  and  an  unofficial  receipt  is  not  in  any  manner 
binding  on  the  Government  and  will  not  be  received  by 
it  as  evidence  of  payment  of  the  tax.**  Deputy  collectors 
may  give  taxpayers,  at  the  time  of  the  payment,  a  per- 
sonal receipt  stating  that  the  amount  of  payment  has 
been  received  to  be  forwarded  to  the  collector.*^ 

Abatement  and  Refund.  The  taxpayer  may  file  a 
claim  for  abatement  of  an  assessment  which  he  thinks 
is  erroneous  after  the  assessment  has  been  made  and 
before  the  tax  is  paid,  or  may  file  a  claim  for  refund  of 
a  tax  which  he  thinks  has  been  erroneously  assessed  after 
the  tax  is  paid.  A  further  discussion  of  this  subject  is 
contained  in  the  chapter  on  abatement  and  refund.*® 

Additional  Assessment.  The  law  provides  that  in 
cases  of  refusal  or  neglect  to  make  a  return  and  in  cases 
of  erroneous,  false,  or  fraudulent  returns,  the  Commis- 
sioner of  Internal  Revenue  shall,  upon  the  discovery 
thereof,  at  any  time  within  three  years  after  the  return 

44  T.  D.  2226. 
46  T.  D.  2341. 
46  See  Chapter  39. 


ASSESSMENT    AND   PAYMENT   OP   THE   TAX  413 

is  due,  or  has  been  made,  make  a  return  upon  informa- 
tion obtained  as  provided  for  in  the  law,  or  require  the 
necessary  corrections  to  be  made,  and  in  such  cases  the 
assessment  made  by  the  Commissioner  of  Internal 
Revenue  thereon  shall  be  paid  by  the  taxpayer  imme- 
diately upon  notification  of  the  amount  of  such  assess- 
ment. The  usual  ten  day  period  of  grace,  however,  ap- 
plies to  such  assessments  as  well  as  to  the  regular  assess- 
ments.*'' Although  the  Commissioner  of  Internal  Reve- 
nue has  power  summarily  to  assess  the  tax  upon  dis- 
covery of  income  which  has  not  been  reported,  yet  if 
such  discovery  is  made  prior  to  the  day  on  which  the 
tax  is  due  (June  15th  or  in  the  case  of  the  corporations 
filing  for  their  fiscal  year  165  days  after  the  closing  of 
the  fiscal  year)  the  tax  cannot  be  summarily  assessed, 
but  may  l)e  paid  at  any  time  before  the  regular  due  date 
with  an  additional  period  of  ten  days  of  grace.*"  Where 
a  summary  assessment  is  made  after  the  regular  due 
date,  the  tax  is  due  immediately  upon  notice  and  demand 
given  by  the  collector,*®  Additional  assessment  may  be 
made  where  the  erroneous  return  is  due  to  an  honest 
mistake,  and  where  the  mistake  is  not  discovered  until 
after  the  tax  is  as.sessed  and  has  been  paid  in  the  regular 
course.*® 

Amended  Returns.  Where  an  individual  or  a  fiduci- 
ary or  a  withholding  agent  has  been  found  subject  to  a 
further  tax  as  a  result  of  the  audit  of  his  return,  or  an 
investigation  made  by  a  revenue  agent,  it  is  not  necessary 
to  file  an  amended  return,  but  the  taxpayer  is  advised 

47  Act  of  September  8,  1916,  {  9  (a)  and  S  14  (a). 

MT.  D.  2003. 

«Reg.  33,  Arts.  177  and  184. 

M  Eliot  National  Bank  v.  Gill,  218  Fed.  600;  134  C.  C.  A.  358. 


414  FEDERAL   INCOME  TAX 

by  letter  of  the  amount  of  additional  tax  to  be  assessed 
and  the  reasons  for  making  such  assessments.^^  In  the 
case  of  corporations  amended  returns  are  required,  but 
the  examining  officers  of  the  Government  are  required  to 
give  the  officers  of  the  corporation  the  fullest  oppor- 
tunity to  make  any  investigation  that  may  be  desired 
prior  to  signing  the  amended  returns,  provided  such 
investigation  does  not  coyer  an  unreasonable  length  of 
time.®^ 

Three- Year  Limitation  on  Summary  Assessment. 
The  statute  authorizes  the  Commissioner  of  Internal 
Revenue  to  make  a  summary  assessment  of  the  tax  on 
undisclosed  income,  if  the  discovery  is  made  within  three 
years  after  the  return  in  which  such  income  should  have 
been  reported  was  due.  It  is  not  necessary  that  the  assess- 
ment be  made  within  three  years,  so  long  as  the  dis- 
covery is  made  within  that  time.  In  computing  the 
three  year  period,  March  1,  the  date  on  which  the  re- 
turns should  have  been  filed  or  was  filed  in  due  course, 
should  be  excluded.  The  general  rule  in^the  interpreta- 
tion of  statutes,  where  time  is  to  be  computed  from  a 
particular  day,  is  to  exclude  the  day  thus  designated 
and  to  include  the  last  day  of  the  specified  period.^' 
The  three  years  limitation  in  this  provision  is  not  a 
limitation  upon  the  right  of  the  Government  to  sue  for 
unpaid  taxes,  but  at  most  is  a  limitation  upon  the  right 
of  the  collecting  officers  to  make  assessment  and  enforce 
the  payment  by  the  summary  statutory  proceedings.''* 

81  Mimeograph  letter  No.  1232  to  Collectors. 

62  Letter  from  Treasury  Department  dated  February  2,  1915; 
I.  T.  S.  1917,  1(1617. 

63  Eliot  National  Bank  v.  Gill,  218  Fed.  600;  134  C.  C.  A.  358; 
National  Bank  of  Commerce  v.  Allen,  223  Fed.  472 ;  139  C.  C.  A.  20. 

64  U.  S.  V.  Grand  Rapids  &  Indiana  Ry.  Co.,  239  Fed.  153. 


ASSESSMENT   AND   PAYMENT   OP   THE  TAX  415 

•  Waiving  the  Three- Year  Limitation.  While  the 
Government  is  fully  authorized  to  recover  taxes  by  suit 
upon  discovery  of  liability  to  original  or  additional  tax 
after  the  three-year  period,  the  Treasury  Department 
prefers  that  the  collection  should  be  made  in  the  or- 
dinary statutory  method,  that  is,  as  a  result  of  a  formal 
assessment.  Jn  order  that  this  may  be  done  taxpayers 
are  requested  to  make  amended  returns  and  to  execute 
waivers  in  such  form  as  will  waive  the  three-year  statu- 
tory limitation.  In  executing  such  waiver,  the  tax- 
payers forfeit  none  of  their  rights  and  assume  no  liabil- 
ity to  any  penalty  that  might  not  be  enforced  against 
them  in  the  absence  of  such  waiver.  If  the  taxpayer, 
against  whom  an  additional  tax  liability  is  discovered, 
will  formally  accept  the  findings  of  the  examining  of- 
ficer and  agree  voluntarily  to  pay  the  tax,  this  amounts 
to  a  waiver  and  neither  amended  returns  nor  waivers 
will  be  required.**  There  seems  to  be  no  objection  to  a 
taxpayer  signing  a  waiver  where  additional  tax  liability 
is  discovered  after  the  expiration  of  the  three-year  period, 
providing  he  does  not  question  the  legality  of  the  assess- 
ment. The  result  of  sibling  a  waiver  will  be  to  compel 
him  to  pay  the  tax  under  protest  and  sue  for  its  re- 
covery, while  if  a  waiver  is  not  signed,  the  Government 
becomes  the  plaintiff  in  an  action  brought  to  collect  such 
tax. 

Refund  op  T.vxes  Collected  on  Second  Assessment. 
Where  a  second  assessment  is  made  in  case  of  a  list,  state- 
ment, or  return,  which  in  the  opinion  of  the  collector  or 
deputy  collector  was  false  or  fraudulent,  or  which  con- 
tained any  understatement  or  undervaluation,  such  as- 
sessment shall  not  be  remitted,  nor  shall  taxes  collected 

S6  Mim.  Letter  No.  1192  to  Collectors. 


416  FEDERAL   INCOME  TAX 

under  such  assessment  be  refunded  or  paid  back,  unless 
it  is  proved  that  said  list,  statement,  or  return  was  not 
false  or  fraudulent,  and  did  not  contain  any  under- 
statement or  undervaluation.*^ 

Interest  on  Delinquent  Taxes,  interest  for  the  full 
time  from  the  second  due  dat«  will  be  collected  on  an 
assessment  the  abatement  for  which  has  been  applied  for 
and  rejected;  that  is  time  consumed  in  considering  the 
claim  must  be  included.*'  Where  penalty  has  been  added 
for  delinquency,  interest  is  reckoned  upon  the  entire 
assessment  including  both  the  tax  and  the  penalty.*®  In- 
terest is  recoverable  as  interest  and  not  as  penalty.** 

Suit  for  Collection  of  Taxes.  Where  net  income  has 
been  incorrectly  stated  in  a  return  and  the  tax  based 
upon  such  return  has  been  paid,  an  action  of  indehitattis 
assumpsit  will  lie  to  recover  the  balance  of  the  tax,  which 
should  have  been  levied  and  paid,  without  any  formal 
assessment  of  such  tax.  Neither  the  limitation  of  three 
years  as  to  summary  assessment,  nor  any  other  statute  of 
limitation  bars  an  action  by  the  United  States  Govern- 
ment to  recover  the  difference  between  the  amount  of 
the  tax  levied  and  paid  and  the  amount  which  should 
have  been  levied  and  paid,  if  the  return  had  correctly 
stated  the  net  income.^®  In  the  collection  of  the  taxes 
imposed  by  statute  the  Government  is  not  confined  to  the 
summary  proceedings  therein  provided,  but  may  resort 
to  a  plenary  suit.     Where  a  tax  of  a  fixed  percentage 

66  E.  S.,  §  3220. 

67  Eeg.  No.  1,  page  110, 

58  T.  D.  870,   February   27,   1905. 
69  U.  S.  V.  Guest,  143  Fed.  456. 
.   60  U.  S,  V.  Minneapolis  Threshing  Machine  Co.,  229  Fed.  1019. 


ASSESSMENT   AND   PAYMENT  OP  THE  TAX  417 

is  imposed  by  the  statute  on  a  subject  or  object  which  is 
so  definitely  described  in  the  statute  that  its  amount  or 
value,  on  which  the  fixed  percentum  is  to  be  calculated, 
can  be  ascertained  and  determined,  on  evidence,  by  a 
court,  a  suit  for  the  tax  will  lie  without  an  assessment.*^ 
Suits  for  the  collection  of  taxes  can  be  brought  at  any 
time  whether  the  taxes  have  been  assessed  or  not,  or 
whether  they  are  or  are  not  assessable.®*  Interest  on 
taxes  sued  for  runs  from  the  time  the  taxes  were  due.^ 

Lien  for  Unpaid  Taxes.  If  any  person  liable  to  pay 
any  tax  neglects  or  refuses  to  pay  the  same  after  de- 
mand, the  amount  shall  be  a  lien  in  favor  of  the  United 
States  from  the  time  when  the  assessment-list  was  re- 
ceived by  the  collector,  except  when  otherwise  provided, 
until  paid,  with  the  interest,  penalties,  and  costs  that 
may  accrue  in  addition  thereto,  upon  all  property  and 
rights  to  property  belonging  to  such  person.®* 

Notice  op  Lien.  The  Government's  lien  for  collection 
of  taxes  is  not  valid  as  against  any  mortgagee,  pur- 
cha.ser  or  judgment-creditor,  until  notice  of  such  lien, 
has  been  filed  by  the  collector  in  the  office  of  the  Clerk 
of  the  District  Court  of  the  District  within  which  the 
property  subject  to  such  lien  is  situated,  and  is  not 
valid  in  a  state  which  by  appropriate  legislation  author- 
izes the  filing  of  such  notice  in  the  office  of  the  registrar 
or  recorder  of  deeds  of  the  counties  of  that  state,  un- 
less the  notice  is  filed  in  the  office  of  such  registrar  or 

61  U.  S.  V.  Grand  Rapids  &  Indiana  Ry.  Co.,  239  Fed.  153  and 
ca-^es  cited  therein. 

88  Dollar  Savings  Bank  v.  U.  S.,  19  Wall.  227 ;  Kane  v.  U.  S., 
99  U.  S.  229;  U.  S.  v.  Little  Miami  Co.  et  al.,  1  Fed.  700. 

68  U.  S.  V.  Erie  R.  R.,  106  U.  8.  327. 

•4R.  8..  §3186. 
F.  I.  Tax.— 27 


418  FEDERAL  INCOME  TAX 

recorder  of  deeds  of  the  county  (or  parish  in  the  State 
of  Louisiana)  within  which  the  property  subject  to  the 
lien  is  situated.^^  A  lien  for  taxes  is  not  similar  to  the 
lien  of  an  ordinary  incumbrance.  It  is  not  displaced 
by  a  sale  under  a  pre-existing  judgment  or  decree,  un- 
less otherwise  directed  by  statute.  It  attaches  to  the 
res  without  regard  to  individual  ownership,  and  when 
it  is  enforced  by  sale  pursuant  to  the  statute  prescribing 
the  mode  of  assessing  and  collecting  taxes,  the  purchaser 
takes  a  valid  and  unimpeachable  title.^^  To  create  a 
lien,  demand  must  be  made  for  a  specific  amount;  all 
steps  required  by  law  must  be  pursued  strictly.  The 
lien  requires  an  assessment,  a  notice  of  the  tax  due,  and 
a  specific  demand  upon  the  individual  taxpayer  for  R^y- 
ment.^''  The  Government  is  not  compelled  to  resort  to 
a  sale  of  chattels  and  personal  effects  of  a  taxpayer,  be- 
fore instituting  proceedings  to  enforce  a  lien  on  the 
taxpayer's  real  estate  and  leaseholds,  and  such  lien  may 
be  enforced  against  the  grantees  of  the  taxpayer's  real 
estate  and  leasehold  interests  subsequent  to  the  filing 
of  the  list  with  the  collector  and  demand  upon  the  tax- 
^payer,  although  the  grantees  had  no  notice  of  the 
lien.®' 

Time  When  Lien  Attaches.  The  statute  expressly 
provides  that  a  lien  for  unpaid  taxes  in  favor  of  the 
United  States  shall  attach  from  the  time  when  the  as- 
sessment-list was  received  by  the  collector,  except  when 

66  See  Act  of  March  4,  1913,  amending  ,,§  3186  B.  S.  Prior  to 
the  Act  of  March  4,  1913,  it  was  not  necessary  to  file  any  notice 
in  compliance  with  State  laws  to  make  a  lien  effective.  (U.  S.  v. 
Snyder,  149  U.  S.  210). 

66  Osterberg  v.  Union  Trust  Co.,  93  U.  S.  424. 

67  U.  S.  V.  Pacific  R.  R.,  1  Fed.  97. 

68  U.  S.  V.  Curry,  201  Fed.  371. 


i 


ASSESSMENT   AND   PAYMENT   OF   THE  TAX  419 

otherwise  provided.  No  other  provision  seems  to  be 
applicable  to  the  income  tax  law.  The  1916  Law  provides 
in  part  that  "all  administrative,  special  and  general  pro- 
visions of  law,  including  the  laws  in  relation  to  assess- 
ment, remission,  collection  and  refund  of  internal- 
revenue  taxes  not  heretofore  specifically  repealed  and 
not  inconsistent  with  the  provisions  of  this  title,  are 
hereby  extended  and  made  applicable  to  all  the  pro- 
visions of  this  title  and  to  the  tax  herein  imposed.  "•• 
Under  the  Income  Tax  Law  it  is  the  duty  of  the  Com- 
missioner of  Internal  Revenue  to  send  to  each  collector 
a  list  of  the  taxpayers  liable  for  the  tax  in  his  district, 
showing  the  amounts  for  which  they  are  liable,  within 
such  time  that  the  collector  may  give  the  required  notice 
of  assessment  on  or  before  the  first  day  of  June,  and 
upon  such  lists  the  collections  are  made.  The  lien  is 
fixed  upon  the  assets  of  the  taxpayer  when  this  list 
comes  into  the  collector's  hands.  In  the  case  of  a  cor- 
poration which  has  distributed  its  assets  prior  to  the 
time  when  a  lien  would  attach  thereto,  the  Government 
may  proceed  to  collect  the  tax  as  a  general  creditor."'® 

Taxes  Collectible  by  Distraint.  If  any  person  liable 
to  pay  any  taxes  neglects  or  refuses  to  pay  the  s^e 
within  ten  days  after  notice  and  demand,  it  shall  be 
lawful  for  the  collector  or  his  deputy  collector  to  col- 
lect the  taxes,  with  the  5%  penalty,  and  interest  at 
the  rate  of  1%  per  month,  by  distraint  and  sale  of  the 
goods,  chattels  or  effects,  including  stocks,  securities, 
and  evidences  of  debt,  of  the  person  delinquent.''*  This 
section  of  the  statute  exempts  certain  property  from 

8»  Act  of  September  8,  1916,  S  22. 

70  See  Chapter  12  on  corporations. 

71  B.  8.,  §  3187. 


420  FEDERAL   INCOME  TAX 

distraint  in  the  case  of  the  head  of  a  family.  Extensive 
provision  is  made  in  the  statute  for  the  mode  of  levy- 
ing distraint  and  pfroceedings  on  distraint.''^ 

72  See  E.  S.,  §§  3188,  et  seq. 


i 


CHAPTER  37 

PENALTIES  AND  COMPROMISES 

Several  penalties  are  contained  in  the  law  for  failure 
to  comply  with  its  provisions  and  for  making  false  or 
fraudulent  statements  in  the  returns.  The  penalties 
take  two  forms:  (a)  specific  penalties  in  the  nature  of 
fines  between  minimum  and  maximum  limits,  and  (b) 
penalties  of  either  50%  or  100%  of  the  amount  of 
tax  due. 

Suit  to  Enjoin  Collection  of  Penalties.  While  Section 
3224  of  the  Revised  Statutes,  which  prohibits  suits  to 
enjoin  the  collection  of  internal  revenue  taxes,  does 
not  specifically  include  "penalties"  as  such,  yet  where 
penalties  are  authorized  by  the  statute  to  be  added  to 
the  tax  and  collected  as  a  part  of  the  tax,  the  courts 
will  hold  that  the  penalty  is  a  part  of  the  tax,  and  its 
collection  cannot  be  enjoined.* 

Failure  to  File  Return  of  Annual  Net  Income.    If  an 

individual  fails  to  file  a  return  the  specific  penalty  is 
not  less  than  $20  nor  more  than  $1,000.*  In  the  case 
of  a  corporation  the  specific  penalty  is  any  amount  not 
exceeding  $10,000.'     In  any  case  of  failure  to  file  a 

1  Kohlham«r  v.  Smietanka,  239  Fed.  408. 
«  Act  of  September  8,  1916,  8  18. 
•  Id.  SU  (c). 

421 


422  FEDERAL   INCOME   TAX 

return  or  list  within  the  time  prescribed  by  law  or  by 
the  collector,  the  Commissioner  of  Internal  Revenue 
also  adds  to  the  tax  50%  of  its  amount.* 

.  Exception.  When  a  return  is  voluntarily,  and  with- 
out notice  from  the  collector,  filed  after  the  time  pre- 
scribed by  law,  and  it  is  shown  that  the  failure  to  file 
was  due  to  a  reasonable  cause  and  not  to  wilful  neglect, 
the  addition  of  50%  of  the  tax  is  not  made.^  The  notice 
referred  to  in  this  provision  of  the  law  is  the  formal 
notice  contemplated  by  Section  3173  of  the  Revised 
Statutes.®  Where  revenue  agents  or  examining  officers 
receive  a  return  after  the  due  date,  or  examine  the 
books  covering  a  delinquent  return  for  the  year  1916, 
or  any  subsequent  year,  the  assessment  of  50%  addi- 
tional will  be  recommended  only  if  such  formal  notice 
had  been  given  prior  to  the  filing  of  the  return,  or  the 
discovery  of  unreported  income.  If  the  formal  notice 
has  not  been  given  prior  to  such  discovery  or  to  the 
making  of  the  return,  a  return  will  be  considered  vol- 
untarily filed,  although  informal  notice  may  have  been 
given  by  the  collector  or  agent.''  This  provision  waiv- 
ing the  penalty  in  case  of  voluntary  filing  is  contained 
in  a  section  of  the  general  revenue  laws  amended  by 
and  contained  in  the  1916  Law  and  has  been  held,  by 
» the  Treasury  Department,  to  apply  only  to  returns 
filed  under  the  1916  Law,  since  Section  24  of  the  1916 
Law  continues  in  force  all  the  provisions  of  the 
1913  Law  for  the  assessment  and  collection  of  taxes 
which  have  accrued  thereunder,  and  for  the  imposition 

4R.  S.  §3176;   T.  D.  1950. 

6  R.  S.  §  3176,  as  amended  by  Act  of  September  8,  1916. 

6  This  notice  is  known  as  Form  1045. 

7  Mimeograph  letter  to  Collectors,  C.  T.  No.  54. 


PENALTIES  AND   COMPROMISES  423 

and  collection  of  all  penalties  and  forfeitures.  In  the 
case  of  delinquent  returns  filed  under  the  1909  and 
the  1913  Laws,  the  respective  provisions  of  those  laws 
will  be  enforced  and  the  additional  tax  assessed,  together 
with  the  specific  penalty.  The  50%  additional  tax  will 
be  assessed,  or  reported  for  assessment,  only  in  those 
cases  under  the  1913  and  1909  Laws  where  the  delin- 
quency was  discovered  within  three  years  from  the  date 
tlie  returns  were  due  to  be  filed,  and  the  specific  pen- 
alty will  be  assessed  only  in  those  cases  in  which  the 
delinquency  was  discovered  within  five  years  from  the 
date  the  returns  were  due.*  The  ruling  of  the  Treasury 
Department  holding  that  the  provision  which  waives  the 
penalty  applies  only  to  returns  filed  under  the  1916 
Law,  does  not  seem  to  take  into  consideration  the  fact 
that  although  the  provision  is  contained  in  the  1916 
Law,  yet  it  is  an  amendment  to  a  section  of  the  revenue 
laws  applying  generally  and,  it  seems,  operates  to  super- 
sede the  penalty  provisions  of  the  1913  Law  and  the 
1909  Law  with  respect  to  all  returns  filed  under  those 
laws  on  and  after  September  9,  1916,  as  well  as  to 
rotnrns  under  the  1916  Law. 

Returns  of  Withholding  Agents.  Failure  to  make 
and  file  withholding  returns  on  or  before  March  1st 
renders  a  withholding  agent  liable  to  the  specific  pen- 
alty or  not  less  than  $20  nor  more  than  $1,000,  but 
the  50%  addition  to  the  tax  for  failure  to  make  a  return, 
and  the  100%  addition  for  intentional  false  or  fraudu- 
lent return,  is  not  assessed  against  withholding  agents." 

8  Mimeograph  letter  to  Collectors,  C.  T.  No.  56. 

9  Mimeograph  letter  to  Collectors,  No.  126.'5. 


4^4  FEDERAL   mCOME  TAX 

Specific  Penalty  Not  Waived  by  Accepting  Return. 

The  specific  penalty  is  not  waived  or  remitted  by  the 
fact  that  the  Commissioner  accepts  a  delinquent  return.^® 

Intentional  Neglect  or  Refusal  to  Make  Returns. 

The  same  specific  penalties  apply  to  intentional  neglect 
or  refusal  to  make  returns  as  apply  to  all  cases  of 
failure  to  make  returns,  but  in  the  case  of  intentional 
neglect  or  refusal  the  penalty  of  100%  of  the  tax  is 
added,  unless  the  neglect  is  due  to  sickness  or  absence.^^ 

False  Returns.  The  law  provides  that  ''in  case  a 
false  or  fraudulent  return  or  list  is  wilfully  made,  the 
Commissioner  of  Internal  Revenue  shall  add  to  the  tax 
100  per  centum  of  its  amount.  This  provision  does  not 
seem  to  include  returns  which  are  false  in  the  sense 
of  containing  mistakes  or  unintentional  misstatements. 
A  return  may  be  false,  in  the  sense  used  in  those  sec- 
tions of  the  law  which  permit  summary  assessments 
in  the  case  of  erroneous,  false  or  fraudulent  returns, 
without  being  false  in  the  sense  used  in  the  provision 
prescribing  the  penalty  tax  of  100%. ^'^  There  seems 
to  be  no  penalty  imposed  in  case  a  return  is  false  in 
the  sense  of  being  incorrect  in  the  absence  of  wilful 
intent  to  make  a  false  return. 

Fraudulent  Returns.  Where  a  false  or  fraudulent 
return  is  wilfully  made  the  Commissioner  of  Internal 
Revenue  adds  to  the  tax  100%   of  its  amount.     This 

10 IT.  S.  V.  Suprise  5,  10  &  19c  Store,  not  yet  officially  reported.- 

11  T.  D.  1950. 

12  Act  of  September  8,  1916,  §  9  (a)  and  §14  (a).  Eliot  Nat. 
Bank  v.  Gill,  218  Fed.  600. 


PENALTIES   AND   COMPROMISES  425 

increase  is  only  made  in  case  the  return  is  fraudulently 
false." 

Fine  Against  Officer  of  Corporation.  In  case  an  offi- 
cer of  a  corporation,  charged  with  the  duty  and  respon- 
sibility of  making  and  verifying  a  return,  makes  a  false 
or  fraudulent  return,  with  the  intent  of  defeating  or 
evading  any  assessment  or  tax,  he  is  guilty  of  a  mis- 
demeanor and  subject  to  a  fine  not  to  exceed  $2,000, 
or  to  imprisonment  not  to  exceed  one  year,  or  both,  at 
the  discretion  of  the  court,  together  with  the  costs 
of  prosecution.^* 

Failure  to  File  Information  at  Source.  Any  person, 
corporation,  partnership,  association  or  insurance  com- 
pany called  upon  to  supply  information  recjuired  by 
the  law,  who  refuses  or  neglects  to  do  so  at  the  time 
or  times  specified  in  each  year,  shall  be  liable  to  a 
penalty  of  not  less  than  $20  nor  more  than  $1,000." 

Failure  to  Withhold  Tax  at  the  Source.  Any  per- 
son required  by  law  to  deduct  and  withhold  the  tax  at  the 
source  is  personally  liable  for  such  tax.** 

Delay  in  Payment  of  the  Tax.  in  the  case  of  indivi- 
duals any  sum  or  sums  due  and  unpaid  after  the  15th 
day  of  June  in  any  year,  and  for  ten  days  after  notice 
and  demand  thereof  by  the  collector,  there  shall  be 
added  the  sum  of  5%  on  the  amount  of  tax  unpaid, 

18  National  Bank  of  Commerce  v.  Allen,  22.3  Fed.  472. 
14  T.  D.  1950,  Act  of  September  8,  1916,  S  18. 
1ft  Act  of  September  8,  1916,  $  18,  as  amended  by  Act  of  October 
|3,  1917. 

WAct  of  September  8,  1916,  S9  (b), 


426  FEDERAL   INCOME  TAX 

and  interest  at  the  rate  of  1%  per  month  upon  said 
tax  from  the  time  the  same  became  due.  In  the  case 
of  corporations,  the  same  penalty,  and  the  same  rate  of 
interest,  is  added  to  any  sum  or  sums  due  and  unpaid 
after  the  15th  day  of  June  in  any  year  (or  after  105 
days  from  the  date  on  which  the  return  of  income  is 
required  to  be  made  in  the  case  of  corporations  report- 
ing for  their  fiscal  years)  and  for  ten  days  after  notice 
and  demand  thereof  by  the  collector.^''  This  penalty 
and  interest  do  not  accrue  in  case  of  any  tax  due  from 
the  estates  of  insane,  deceased  or  insolvent  persons, 
where  the  return  was  made  by  the  incapacitated  per- 
son and  he  becomes  insane,  or  dies,  or  becomes  insolvent, 
after  making  the  return  and  prior  to  the  required  date 
of  payment  of  the  tax.^'  When  an  assessment  has  been 
made  for  a  tax  or  penalty  and  within  ten  days  after 
demand  a  claim  for  abatement  is  filed,  and  accepted 
by  the  collector,  the  time  ceases  to  run  against  the 
claimant  as  to  the  5%  penalty,  until  the  claim  is  re- 
jected. Upon  receipt  of  the  notice  of  rejection  of  the 
claim,  the  tax  may  be  paid  within  ten  days  from 
the  date  of  the  notice,  without  penalty.  Interest  at  the 
rate  of  1%  per  month,  however,  continues  to  run  and 
is  collected  for  the  full  number  of  calendar  months 
which  intervene  between  the  date  of  the  expiration  of 
the  first  ten  days'  notice  and  the  date  of  payment  of  the 
tax,  notwithstanding  that  a  claim  for  abatement  has 
been  filed.^® 

17  Act  of  September  8,  1916,  §9  (a)  and  §  14  (a)." 

18  Letter  from  Treasury  Department  dated  April  1,  1916; 
T.  S.  1917,  II  476. 

19  Keg.  No.  14,  October  15,  1911 ;  Eeg.  No.  1,  page  110. 


PENALTIES  AND   COMPROMISES  427 

Statute  of  Limitations.  The  Revised  Statutes  *®  pro- 
vide that  no  suit  or  prosecution  for  any  penalty  or 
forfeiture,  pecuniary  or  otherwise,  accruing  under  the 
laws  of  the  United  States,  shall  be  maintained,  except 
in  cases  where  it  is  otherwise  specially  provided,  unless 
the  same  is  commenced  within  five  years  from  the  time 
when  the  penalty  or  forfeiture  accrued.  The  statute 
does  not  run,  however,  if  the  person  liable  for  the 
penalty  is  not  to  be  found  within  the  United  States 
so  that  proper  process  may  be  served  against  him. 

Compromise  of  Penalties.  The  Commissioner  of  In- 
ternal Revenue,  with  the  advice  and  consent  of  the 
Secretary  of  the  Treasury,  may  compromise  any  civil 
or  criminal  case  arising  under  the  internal  revenue  laws 
instead  of  commencing  suit  thereon ;  and,  with  the  advice 
and  consent  of  the  said  Secretary,  and  the  recommenda- 
tion of  the  Attorney  General,  he  may  compromise  any 
case  after  a  suit  thereon  has  been  commenced.  "When- 
ever a  compromise  is  made  in  any  case  there  shall  be 
placed  on  file  in  the  office  of  the  Commissioner  the 
opinion  of  the  ^Solicitor  or  Internal  Revenue,  or  of  the 
officer  acting  as  such,  with  his  reasons  therefor,  with 
a  statement  of  the  amount  of  tax  assessed,  the  amount 
of  additional  tax  or  penalty  imposed  by  law  in  conse- 
quence of  the  neglect  or  delinquency  of  the  person 
against  whom  the  tax  is  assessed,  and  the  amount 
actually  paid  in  accordance  with  the  terms  of  the  com- 
promise." He  has  under  this  section  no  power  to 
compromise  a  suit  against  the  Government,'*  the  power 

W  R.  S.,  S  1047. 

SI  R.  S.,  §  3229 ;   see  §  3469,  as  to  compromise  of  cases  after 
judgment. 
W  23  Op.  Atty.  Gen.  507. 


428  FEDERAL   INCOME   TAX 

f  being  limited  to  suits  which  the  Government  may  prose- 

cute. A  compromise  operates  for  the  protection  of  the 
offender  against  subsequent  proceedings  as  fully  as  a 
formal  conviction  or  acquittal,  and  is  a  bar  to  further 
action.*'  Where  an  action  is  brought  by  the  United 
States  against  a  delinquent  taxpayer,  for  having  failed 
to  file  a  return,  the  verdict  must  specifically  state  the 
amount  of  the  penalty,  after  which  the  only  remedy 
of  the  defendant  (other  than  an  appeal)  is  to  apply 
for  a  compromise.**  Offers  in  compromise  should  in- 
clude payments  of  cost.**  The  amount  of  the  offer  should 
be  deposited  with  the  Commissioner,  but  cannot  be  held 
or  set  off  against  the  tax  due.** 

Specific  Penalties.  While  the  sections  of  the  Re- 
vised Statutes  relating  to  compromises  *"'  do  not  in 
express  language  refer  to  the  compromise  of  the  spe- 
cific penalty  for  failure  to  file  the  return,  neither  are 
they  restricted  in  terms,  nor  by  any  reason  of  public 
policy,  to  penalties  for  the  non-payment  of  taxes.  In 
the  opinion  of  the  Attorney  General  the  application 
of  these  sections  to  compromise  of  penalties  for  failure 
to  file  returns  in  time  is  proper,  and,  further,  that  in 
such  compromises  the  Commissioner  is  authorized  to 
consider  not  only  the  pecuniary  interests  of  the  Treas- 
ury, but  also  general  considerations  of  justice,  equity 
and  public  policy.*^ 

28  U.  S.  V.  Chouteau,  102  U.  S.  603. 

84  V.  S.  V.  Acorn  Eoofing  Co.,  204  Fed.  157. 

85  T.  D.  642,  March  20,  1903. 

86  Boughton  v.  U.  S.,  12  Ct.  Cls.  330. 

87  R.  S.,  §§3229  and  3469. 

88  29  Op.  Atty.  Gen.  217. 


PENALTIES  AND   COMPROMISES  429 

Fifty  Per  Cent.  Increase  op  Tax.  The  penalty  of 
50%  increase  in  tax  for  failure  to  file  returns  is  found 
in  practically  all  revenue  laws  relating  to  special  taxes, 
and  the  uniform  construction  has  been  that  no  admin- 
istrative officer  is  clothed  with  authority  to  compromise 
such  increase  in  tax.*®  The  income  tax  law  is  explicit 
and  mandatory  in  its  provisions  relative  to  the  addi- 
tional assessment  of  50%  of  the  tax  otherwise  due,  in 
case  of  failure  to  file  a  return  of  income  within  the 
prescribed  time,  and  does  not  give  discretionary  author- 
ity for  remission  of  these  additional  taxes  to  any  officer 
of  the  Government.*''  Since  the  50%  penalty  was  not 
subject  to  compromise  under  the  general  revenue  laws. 
Congress  passed  an  act  providing  particularly  for  the 
refund  of  such  additional  taxes,  assessed  under  the  1909 
Law,  for  neglect  to  file  returns,  '*  but  no  such  statute 
has  been  passed  with  respect  to  penalties  incurred  under 
the  1913  Law  or  the  1916  Law. 

Offers  in  Compromise.  It  is  the  practice  of  the 
Treasury  Department  to  accept,  as  a  minimum  offer, 
$5  from  individuals  and  withholding  agents,  and  $10 
from  corporations,  in  compromise  of  the  specific  pen- 
alty incurred  for  failure  to  file  returns,  in  cases  where 
the  neglect  was  not  intentional.'*  Offers  in  compromise 
do  not  receive  favorable  consideration  in  cases  where 
returns  for  the  year  in  question  have  not  been  filed, 
but  such  offers  are  accepted  "subject  to  the  filing  of 
the  return. "  **     No  particular  form  is  prescribed  for 

WT.  D.  1701. 

SOT.  D.  2135. 

81  Act  of  March  3,  1913. 

88  T.  D.  2311;  T.  D.  2349. 

88  T.  D.  2311. 


430  FEDERAL   INCOME   TAX 

use  in  making  offers  in  compromise  of  the  specific 
penalties,  and  such  offer  may  be  made  in  the  form  of 
a  letter  addressed  to  the  local  collector.  Each  offer 
in  compromise  should  be  accompanied  by  an  affidavit 
in  which  the  proponent  should  state  briefly  the  facts 
which  caused  the  delinquency.  Where  affidavits  allege 
facts  that  no  delinquency  was  incurred  or  recite  cir- 
cumstances which  warrant  relief  from  the  specific 
penalty,  the  offer  is  returned,  unless  there  are  facts 
in  the  possession  of  the  collector  at  variance  with  the 
contentions  made  by  the  proponents.  All  delinquents 
who  do  not  compromise  their  liabilities  to  the  specific 
penalty,  after  ample  opportunity,  are  reported  to  the 
United  States  District  Attorney  for  ^proceedings.^*  It 
is  the  duty  of  every  District  Attorney  to  prosecute 
every  case  for  the  collection  of  a  fine,  penalty  or  for- 
feiture reported  to  him  by  any  collector,  unless,  upon 
inquiry  and  examination,  he  decides  that  such  proceed- 
ings cannot  properly  be  sustained,  or  that  the  needs 
of  public  justice  do  not  require  that  such  proceedings 
be  instituted;  in  which  case  he  reports  the  facts  to  the 
Commissioner  of  Internal  Revenue  for  his  direction.^* 

34  T.  D.  2311. 
86  B.  S.,  §  838. 


CHAPTER  38 

EXAMINATION  OP  TAXPAYERS'  BOOKS 

For  the  purpose  of  verifying  returns  the  Commis- 
sioner of  Internal  Revecue  may,  by  any  duly  author- 
ized revenue  agent  or  deputy  collector,  cause  the  books 
of  a  taxpayer  to  be  examined,  and  if  such  examination 
discloses  that  the  taxpayer  is  liable  to  tax  in  addition 
to  that  previously  assessed,  the  same  is  assessed  and 
becomes  payable  within  ten  days  from  the  time  of  send- 
ing the  taxpayer  a  notice  and  demand.  For  the  purpose 
of  such  examination  the  books  of  the  taxpayer  shall 
be  opened  to  the  examining  officer,  or  shall  be  produced 
upon  a  summons  issued  by  any  properly  authorized 
officer.*  The  authority  for  making  such  exai\iination 
of  the  taxpayer's  books  is  contained  in  Sections  3172, 
3173  and  3176  of  the  Revised  Statutes,  as  amended 
by,  and  contained  in,  the  1916  Law.  Under  these  gen- 
eral provisions  applying  to  all  revenue  taxes,  a  collector 
may  send  out  his  deputies  to  make  inquiries.  If  any 
person  refuses  to  allow  any  regidarly  authorized  Gov- 
ernment officer  to  examine  his  books  or  the  books  of 
the  person,  firm,  or  corporation  for  whom  he  is  agent, 
it  is  lawful  for  the  collector  to  summon  such  person, 
or  any  other  person  having  possession,  custody  or  care 
of  the  books  of  account  containing  entries  relating  to 
the  business   of   such   taxpayer,   or  any  other   person 

1  Reg.  33,  Art.  186. 

431 


432  FEDERAL  INCOME  TAX 

he  may  deem  proper,  to  appear  before  him  and  pro- 
duce the  books  at  a  time  and  place  named  in  the  sum- 
mons, to  give  testimony  or  answer  interrogatories  under 
oath,  respecting  any  objects  or  income  liable  to  tax, 
or  the  returns  thereof.  The  collector  may  summon  any 
person  residing  or  found  within  the  state  or  territory 
in  which  his  district  lies;  and  when  the  person  intended 
to  be  summoned  does  not  reside  and  cannot  be  found 
within  such  state  or  territory,  he  may  enter  any  col- 
lection district  where  such  person  may  be  found  and 
there  make  the  examination  authorized  by  the  law.  If 
the  taxpayer  fails  to  make  a  return  or  makes,  wilfully 
or  otherwise,  a  false  or  fraudulent  return,  the  collector 
or  deputy  collector  is  authorized  to  make  the  return 
from  his  own  knowledge  and  from  such  information 
as  he  can  obtain  through  testimony  or  otherwise.*  Sec- 
tion 3173  of  the  Revised  Statutes  clothes  collectors  of 
internal  revenue  with  supervisory  powers  over  and 
authorizes  them  to  investigate  all  accounts,  lists,  or 
returns  made  or  required  to  be  made  to  them  by  any 
and  all  classes  of  persons  liable  to  pay  taxes  upon  any 
property,  trade  or  business.'  It  has  also  been  held  that 
the  examination  of  books  under  this  section  is  not  an 
infringement  of  the  Constitution.*  In  all  suits  and  pro- 
ceedings, other  than  criminal,  arising  under  any  of  the 
revenue  laws  of  the  United  States,  the  attorney  repre- 
senting the  Government  may,  whenever  in  his  belief 
any  business-book,  invoice,  or  paper,  belonging  to  or 
under  the  control  of  the  defendant  or  claimant,  will 
tend  to  prove  any  allegation  made  by  the  United  States, 

1 

2E.  S.,  §§  3173  and  3176,  as  amended  by  Act  of  September  8, 

1916. 

3  U.  S.  V.  Hodson,  14  Int.  Rev.  Eec.  100. 

4  In  re  Strouse,  1  Sawyer  605.  ^ 


EXAMINATION   OF   T.VXPAYERS'    BOOKS  433 

make  a  written  motion  particularly  describing  such 
book,  invoice,  or  paper,  and  setting  forth  the  allegation 
which  he  expects  to  prove;  and  thereupon  the  court 
may,  at  its  discretion,  issue  a  notice  to  the  defendant 
or  claimant  to  produce  the  same.  Upon  failure  to  do 
so  the  allegation  stated  in  the  motion  is  taken  as  con- 
fessed, unless  the  failure  or  refusal  is  explained  to  the 
satisfaction  of  the  court.*  This  provision  applies  to 
proceedings  under  the  Internal  Revenue  laws  as  well 
as  the  customs  revenue  laws.® 

Instructions  to  Revenue  Agents.  The  following  in- 
structions have  been  given  by  the  Treasury  Department 
to  revenue  agents  and  examiners :  "In  conducting  their 
examination  the  agents  will,  except  in  clear  cases  of 
misrepresentation,  proceed  on  the  assumption  that  all 
errors  in  the  returns  rendered  are  unintentional;  and 
they  will,  so  far  as  possible,  make  their  examination 
in  such  manner  as  not  to  interfere  with  the  company's 
business,  either  as  to  the  use  of  its  books  or  in  the 
general  conduct  of  its  affairs.  Contentions  with  oflfi- 
eers,  employees  or  representatives  of  corporations  are 
to  be  carefully  avoided,  and  no  action  that  may  cause 
friction,  that  is  not  necessary  in  the  proper  perform- 
ance of  their  duties,  must  be  indulged  in  by  oflScers 
making  these  examination.s.  Ordinarily  no  very  extended 
examination  of  the*  company 's  books  will  be  necessarj', 
as  the  verification  of  the  particular  items  to  which  atten- 
tion has  been  called  will  be  sufficient.  Where,  however, 
a  thorough  examination  is  found  to  be  necessary,  and 
the  accounts  are  so  kept  as  to  involve  much  labor  in 
their  examination,  the  agent  may  assign  two  assistants 

6  Act  of  June  22,  1874,  18  Stat.  187. 
6  U.  S.  V.  Distillery,  21  Int.  Rev,  Rec.  366. 
F.  I.  Tax.— 28 


434  FEDERAL   INCOME   TAX 

for  this  purpose.  Where  discrepancies  between  the 
company's  books  and  the  return  made  are  discovered, 
the  officers  of  the  company  should  be  given  full  oppor- 
tunity to  explain  the  same,  and  to  furnish,  if  so  desired, 
a  sworn  statement  in  reference  thereto.  In  such  cases 
the  agent  will,  if  deemed  necessary,  require  the  attend- 
ance of  any  officer  or  employee  of  the  company,  and 
there  examine  such  officer  or  employee  respecting  the 
matter  under  investigation.  The  witnesses  in  such  cases 
should  be  duly  sworn  by  the  agent,  and  in  case  of 
refusal  of  any  such  officer  or  employee  to  testify,  or 
in  the  case  of  refusal  to  produce  the  books  or  papers 
called  for,  the  agent  will  at  once  report  the  fact  to 
this  office.  "7 

■TT.  D.  1617. 


CHAPTER  39 

ABATEMENT,   REFUND  AND   RECOVERY   OP   TAXES 

The  prompt  collection  of  the  revenue  and  its  faith- 
ful application  is  one  of  .the  most  vital  duties  of 
Government.  Depending,  as  the  Government  does,  upon 
its  revenue  to  meet  not  only  its  current  expenses,  but 
to  pay  the  interest  on  its  debt,  it  is  of  the  utmost  impor- 
tance that  it  should  be  collected  with  despatch,  and 
that  tlie  ofificers  of  the  Treasury  should  be  able  to  make 
a  reliable  estimate  of  means  in  order  to  meet  liabilities. 
It  would  be  difficult  to  do  this,  if  the  receipts  paid 
into  the  Treasury  were  liable  to  be  taken  out  of  it,  on 
suits  for  alleged  errors  and  mistakes,  concerning  which 
the  officers  charged  with  the  collection  and  disbursement 
of  the  revenue  had  received  no  information.  To  guard 
against  such  consequences,  Congress  has  from  time  to 
time  passed  laws  on  the  subject  of  the  revenue,  which 
not  only  provide  for  the  manner  of  its  collection,  but 
also  point  out  a  way  in  which  errors  can  be  corrected. 
These  laws  constitute  a  system  which  Congress  has  pro- 
vided for  the  benefit  of  those  persons  who  complain 
of  illegal  assessments  of  taxes  and  illegal  exactions  of 
duties.  The  party  aggrieved  can  test  the  question  of 
the  illegality  of  an  assessment  or  collection  of  taxes 
by  suit;  but  he  cannot  do  this  until  he  has  taken  an 
appeal  to  the  Commissioner  of  Internal  Revenue.  Thus 
it  will  be  seen  that  the  person  who  believes  he  has  suf- 
fered wrong  at  the  hands  of  the  collector  can  appeal 

435 


436  FEDERAL   INCOME   TAX 

to  the  courts;  but  he  cannot  do  this  until  he  has  taken 
an  intermediate  appeal  to  the  Commissioner,  and,  in 
any  event,  he  is  barred  from  bringing  a  suit,  unless 
he  does  it  within  the  period  limited  by  law.  The  object 
of  these  different  provisions  is  apparent.  While  the 
Government  is  desirous  to  secure  to  the  citizen  a 
mode  of  redress  against  erroneous  assessments  or  col- 
lections, it  says  to  him:  "We  want  all  controverted 
questions  concerning  the  revenue  settled  speedily,  and 
if  you  have  complaint  to  make,  you  must  let  the  Com- 
missioner of  Internal  Revenue  know  the  grounds  of  it; 
but  if  he  decides  against  you,  or  fails  to  decide  at  all, 
you  can  test  the  question  in  the  courts  if  you  bring 
your  suit  within  a  limited  period  of  time."  ^  The  Com- 
missioner of  Internal  Revenue,  subject  to  regulations 
prescribed  by  the  Secretary  of  the  Treasury,  is  author- 
ized, on  appeal  made  to  him,  to  remit,  refund,  and 
pay  back  all  taxes  erroneously  or  illegally  assessed, 
or  collected,  all  penalties  collected  without  authority, 
and  all  taxes  that  appear  to  be  unjustly  assessed  or 
excessive  in  amount,  or  in  any  manner  wrongfully 
collected.^ 

Taxes  Paid  on  Second  Assessment.  Where  a  second 
assessment  has  been  made  by  the  collector  ^  in  case  of 
a  list  statement  or  return  which,  in  the  opinion  of  the 
collector,  or  deputy  collector,  was  false  or  fraudulent, 
or  contained  any  understatement  or  undervaluation, 
such  assessment  shall  not  be  remitted,  ^nor  shall  taxes 
collected  under  such  assessment  be  refunded,  or  paid 

1  Nichols  V.  United  States,  7  Wall.  122;  U,  S.  v.  Real  Estate 
Savings  Bank,  104  TJ.  S.  728. 

2  R.  S.,  §  3220. 

8  See  Chapter  36. 


ABATEMENT,    REFUND    AND    RECOVERY    OF   TAXES      437 

back,  unless  it  is  proved  that  said  list  and  statement,  or 
return,  was  not  false  or  fraudulent,  and  did  not  con- 
tain any  understatement  or  undervaluation.* 

Who  May  Claim  Recovery  of  Tax.  As  a  general  rule, 
the  taxpayer  against  whom  the  tax  is  assessed  and  by 
whom  the  tax  is  paid  is  the  one  who  is  entitled  to  claim 
abatement  or  refund  or  sue  for  its  recovery.  In  cases 
where  the  tax  has  been  withheld  at  the  source  the 
claim  for  abatement  or  refund  may  be  made  either 
by  the  withholding  agent  against  whom  the  assessment 
was  made  or  by  the  person  for  whose  account  such  taxes 
were  withheld.*  Where  one  corporation  had  leased  all 
of  its  property  to  another,  a  tax  being  thereafter  assessed 
upon  the  lessor,*  and  its  claim  for  an  abatement  being 
rejected,  the  tax  was  paid  by  the  lessee  to  avoid  the 
penalty  threatened  by  the  collector  and  to  avoid  dis- 
traint and  sale  of  the  leased  property.  The  court  held 
that  the  payment  by  the  lessee  was  not  voluntary  and 
that  it  was  entitled  to  sue  for  its  recovery  without 
regard  to'  privity  of  contract  between  it  and  the 
collector.® 

Abatement.  The  Secretary  of  the  Treasury  has  pro- 
vided two  forms  for  the  purpose  of  refund  and  abate- 
ment. One  is  made  applicable  to  the  return  of  taxes 
and  penalties  illegally  or  improperly  assessed  and 
paid,  and  the  other  for  an  abatement  of  tlieir  assess- 
ment. The  former  is  applicable  to  cases  where  the 
taxes  and  penalties  have  been  paid,  and  the  latter  to 
cases  where  they  have  not  been  paid.    These  regulations 

4B.  S.,  5  3220. 

SReg.  S3,  Art.  33. 

6  Cambria  Steel  Co.  t.  McCoach,  225  Fed.  278. 


438  FEDERAL   INCOME  TAX 

of  the  Secretary  have  the  force  of  law,  and  the  Federal 
Courts  are  obliged  to  take  notice  of  them.  Further- 
more, they  are  obviously  binding  upon  the  Commissioner 
and  he  obtains  jurisdiction  to  pass  upon  a  claim  only 
when  and  as  they  have  been  complied  with.  The  merits 
of  a  case  come  before  him  when  a  proper  claim  has 
been  made.  Under  a  claim  for  abatement  he  can  only 
determine  whether  or  not  the  assessment  should  be 
abated.  Any  further  action  would  be  in  violation  of 
the  regulations  and  beyond  his  jurisdiction.'  The  Com- 
missioner possesses  no  equity  powers  in  case  of  abate- 
ment; if  the  tax  is  a  legal  one  he  cannot  abate  it.^  It 
seems  that  the  Commissioner  has  no  authority  to  revoke 
the  abatement  of  a  tax  once  made  by  him,  but  he  may 
re-assess  the  tax.® 

Effect  of  Rejection  of  Claim  for  Abatement.  By 
weight  of  authority  it  seems  that,  if  an  appeal  is  taken 
from  an  assessment  and  decided  against  the  appellant, 
and  the  tax  is  afterwards  collected,  it  is  not  necessary 
to  take  a  second  appeal  for  refund  of  the  payment 
before  commencing  suit  to  recover  the  tax.^®  When 
the  abatement  claim  has  been  considered  and  rejected 
upon  its  merits,  no  claim  for  refund  is  necessary  to 
lay  foundation  for  a  suit.^^  In  a  recent  case  it  was 
said:  ''What  the  Commissioner  of  Internal  Eevenue 
thought  about  the  assessment  had  been  obtained  upon 

1  Hastings  v.  Herold,  184  Fed.  759. 

8  Decision  No.  180,  36  Int.  Eev.  Eec.  13. 

9U.  S.  V.  Alexander  et  al.,  110  U.  S.  325. 

10  San  Francisco  Savings  Society  v.  Gary,  2  Sawyer  393. 

llDeBary  v.  Dunne,  162  Fed.  961;  Schwarzschild  and  Suls- 
berger  Co.  v.  Eucker,  143  Fed.  656;  T.  D.  974;  Grier  v.  Tucker, 
150  Fed.  657;  T.  D.  1293;  Contra,  Hastings  v.  Herold,  184  Fed. 
759. 


ABATEMENT,   REFUND   AND   RECOVERY   OF   TAXES     439 

full  statement  of  the  facts,  and  it  would  have  been  a 
useless  form  again,  after  the  tax  was  paid,  to  appeal 
to  the  Commissioner  and  obtain  the  sam^  judgment. 
The  reason  for  the  appeal  did  not  exist,  and  hence  the 
appeal  after  the  tax  was  paid  was  not  necessary."^* 
This  seems  to  be  the  general  rule,  but  it  has  also  been 
held  to  the  contrary  that  under  a  claim  for  abatement 
the  Commissioner  can  only  determine  whether  or  not 
the  assessment  should  be  abated.  Any  further  action 
would  be  in  violation  of  the  regulations  and  beyond 
liis  jurisdiction,  and  where  the  abatement  was  rejected, 
but  no  application  was  made  for  refund  after  paying 
the  tax,  it  was  held  that  a  suit  could  not  be  main- 
tained.*^ 

Procedure  for  Claiming  Abatement.  Claim  for 
abatement  of  taxes  or  penalties  erroneously  or  illegally 
assessed,  or  which  are  abatable  under  remedial  acts, 
etc.,  must  be  made  out  on  the  form  prescribed  by  the 
Government  **  and  must  be  sustained  by  the  affidavits 
of  the  parties  against  whom  the  taxes  were  assessed, 
or  of  other  parties  cognizant  of  the  facts.**  The  prac- 
tice is  to  obtain  the  oflBcial  form  from  the  local  col- 
lector, prepare  it  according  to  instructions  and  file  it 
with  the  local  ^collector.  The  claim  for  abatement  can 
only  be  made  between  the  time  the  tax  is  assessed  and 
the  date  it  is  due.  If  the  claim  has  not  been  acted  upon 
within  ten  days  after  notice  and  demand  for  the  tax, 
interest  will   accrue  from  the  due  date,  but   the   5% 

12  Weaver  v.  Ewers,  195  Fed.  247. 

13  Hastings  v.  Herold,  184  Fed.  759.  The  weight  of  authority 
seems  to  be  contrary  to  the  rule  in  this  case. 

14  The  form  prescribed  by  the  Government  is  known  as  Form  47. 
16  Reg.  No.  14,  Rev.  October  15,  1911. 


440  FEDERAL   INCOME  TAX 

penalty  for  failure  to  pay  the  tax  will  not  accrue  if 
the  tax  is  paid  within  ten  days  after  the  claim  for 
abatement  is  rejected.^* 

Refund.  Where  the  Commissioner  of  Internal  Reve- 
nue, in  a  case  within  the  scope  of  his  authority  and 
jurisdiction,  has  ordered  a  refund,  a  court  cannot  inquire 
as  to  the  sufficiency  of  the  evidence  before  him,^'  and 
neither  the  Comptroller  of  the  Treasury  nor  any  account- 
ing officer  has  authority  to  review  the  Commissioner's 
decision.^^  Decisions  by  the  Commissioner  of  Internal 
Revenue,  in  cases  where  a  refund  is  directed,  are 
binding  and,  in  the  absence  of  fraud,  or  mistake  of 
calculation,  not  subject  to  revision.^®  The  Commis- 
sioner's decision  is  conclusive  as  to  the  questions  of 
fact,^®  but  apparently  not  as  to  questions  of  law.^^  His 
decisions  are  in  the  nature  of  awards  made  by  arbi- 
trators, and  generally  speaking  bind  both  the  claimant 
and  the  Government.  A  refund  may  be  impeached  for 
fraud,  want  of  jurisdiction,  mistake  apparent  in  the 
certificate,  or  for  such  irregularities  as  would  avoid 
an  award.**  The  Commissioner  of  Internal  Revenue 
may  reconsider  and  revoke  an  allowance  for  refund 
at  any  time  before  the  allowance  is  paid,  but  whether 
a  commissioner  has  power  to  revoke  an  allowance  made 
by  his  predecessor  is  not  clear.*^     Where  one  Commis- 

16  See  Chapter  36. 

17  Woollier  v.  U.  S.,  13  Ct.  Cls.  355. 

18  Bank  of  Greencastle  v.  U.  S.,  15  Ct.  Cls.  225. 

19  Dugan  v.  U.  S.,  34  Ct.  Cls.  458. 

20  U.  S.  V.  Wright,  11  Wall.  (548. 

21  6  Comp.  Dec.  259. 

22  Dugan  v.  U.  S.,  34  Ct.  Cls.  458;  Cumming  v.  U.  S.,  22  Ct, 
Cls.  344. 

88  Bidgway  v.  IT.  S.,  18  Ct.  Cls.  707. 


ABATEMENT,   REFUND   AND  RECOVERY   OP  TAXES     441  * 

sioner  recommended  the  allowance  of  the  claim  and 
referred  the  matter  to  the  Secretary  of  the  Treasury 
for  advisement,  a  succeeding  Commissioner  to  whom 
the  matter  was  referred  back  could  reject  the  claim.** 
The  Commissioner  is  not  precluded  from  allowing  a 
claim  for  refund  because  a  former  Commissioner 
rejected  a  claim  for  abatement,  and  he  is  authorized 
to  reconsider  and  allow  a  claim  which  he  had,  through 
error  of  law,  previously  rejected.  An  application  for 
the  refund  of  taxes,  though  informal  or  defective,  may 
be  regarded  as  a  claim,  so  far  at  least  as  to  permit  a 
formal  amendment  to  be  filed  after  the  statute  of 
limitations  has  run.**  The  Commissioner  of  Internal 
Revenue  has  no  authority  to  remit  the  50%  penalty 
unless  it  is  illegally  collected.  The  words  "wrongfully 
collected"  are  construed  as  synonymous  with  the 
words  "illegally  collected."  No  equity  powers  are 
conferred  on  the  Commissioner,  and  the  Commissioner 
is  authorized,  not  obliged,  to  .refund.*® 

Statute  op  Limitations.  All  claims  for  refund  must 
be  presented  to  the  Commissioner  of  Internal  Revenue 
within  two  years  next  after  the  cause  of  action  accrued.*'' 
Presentation  to  the  collector  is  equivalent  to  presenta- 
tion to  the  Commi.ssioner.**  Where  a  protest  was  held 
by  the  Commissioner  to  be  an  informal  appeal,  and  a 
formal  application  for  refund  was  thereafter  acted 
upon,  although  made  after  the  expiration  of  two  years, 
his  decision  was  held  to  be  conclusive  and  could  not 

2*  Stotesbury  v.  U.  S.,  2.3  Ct.  Cls.  285. 

25  14  Op.' Atty.  Gen.  615, 

26  16  Op.  Atty.  Gen.  667;   13  Op.  Atty.  Gen.  439. 

27  R.  S.,  S  3228. 

M  Real  Estate  Savings  Bank  v.  U.  S.,  16  Ct.  Cls.  335;  104  U.  S. 
728. 


442        ,  FEDERAL   INCOME  TAX 

be  set  aside  by  the  court.^    Failure  to  make  a  claim 
for  refund  within  two  years  after  paying  the  tax  is 

a  bar  to  a  suit  thereon,^® 

« 

When  ST'ATute  of  Limitation  Is  Extended.  Al- 
though generally  the  provisions  of  Section  3228  limit 
all  claims  for  refund  to  a  period  of  two  years  after 
the  tax  has  been  paid,  an  extension  of  this  time  is 
granted  in  cases  where,  upon  examination  of  any  return 
of  income  made  pursuant  to  the  1916  Law,  the  1913  Law 
or  the  1909  Law,  it  appears  that  amounts  of  tax  have 
been  paid  in  excess  of  those  properly  due.  In  such 
cases  the  taxpayer  is  permitted  to  present  a  claim  for 
refund,  notwithstanding  the  provisions  of  Section  3228.'^ 
This  provision  was  inserted  as  a  remedy  in  cases  where 
an  agent  of  the  Treasury  Department  makes  an  exam- 
ination of  a  taxpayer's  books  within  three  years  after 
a  return  has  been  filed  and  discovers  undisclosed  income. 
An  examination  may  also  disclose  an  overpayment,  as 
well  as  undisclosed  income,  in  which  case  the  result 
of  the  examination  may  operate  to  the  benefit  of  the 
taxpayer  as  well  as  to  the  benefit  of  the  Government, 
regardless  of  the  statute  of  limitations.  Claims  once 
rejected  by  the  Commissioner,  because  of  the  statute 
of  limitation  in  existence  at  that  time,  may  be  reopened 
under  this  provision,  if  the  adjustment  necessitates  an 
examination  of  the  return,  but  not  otherwise.^^ 

Procedure.  The  provisions  for  claiming  refund  must 
be  strictly  complied  with.^^     Claim  for  the  refunding 

29  First  Nat.  Bank  of  Greencastle  v.  U.  S.,  15  Ct.  Cls.  225. 

30  Kings  County  Savings  Institution  v.  Blair,  116  U.  S.  200. 

31  Act  of  September  8,  1916,  §  14. 

32  T.  D.  2396. 

33  Public  Service  Railway  Co.  v.  Herold,  219  Fed.  301 ;  Public 
Service  Gas  Co.  v.  Herold,  277  Fed.  496. 


ABATEMENT,    REFUND   AND   RECOVERY   OP   TAXES      443 

of  assessed  taxes  and  penalties  must  l^e  made  out  upon 
the  form  prescribed  by  the  Government.  The  burden 
of  proof  rests  upon  the  claimant.  All  the  facts  relied 
upon  in  support  of  the  claim  must  be  clearly  set  forth, 
under  oath.^*  The  practice  is  to  obtain  a  copy  of  the 
form  from  the  local  collector,  prepare  it  according  to 
instructions  thereon,  and  file  it  with  the  local  collector 
for  further  action.  The  collectors  of  internal  revenue 
and  revenue  oflRcers  are  forbidden  to  prepare  affidavits 
for  persons  claiming  remission  of  taxes  or  penalties 
under  the  internal  revenue  law.*'  An  appeal  for  abate- 
ment or  refund  is  imperfect  if  it  does  not  have  endorsed 
thereon  the  affidavit  of  the  deputy  collector  and  cer- 
tificate of  the  collector  required  by  the  regulations,*® 
but  this  is  a  matter  of  action  within  the  Department. 

Suits  to  Recover  Taxes.  If  a  claim  is  rejected  by  the 
Commissioner,  a  judicial  remedy  is  given  the  taxpayer 
by  an  action  against  the  collector  or  the  United  States. 
If  the  claim  is  allowed  by  the  Commissioner  and  pay- 
ment refused  by  the  accounting  officers,  a  suit  may 
be  brought  directly  against  the  Government  in  the  Court 
of  Claims,"  The  allowance  of  the  claim  by  the  Com- 
missioner may  be  used  as  the  basis  of  an  action  against 
the  United  States  in  the  Court  of  Claims,  when  pay- 
ment is  not  made  by  reason  of  the  refusal  of  any  of 
tlie  officers  of  the  Department  to  pass  or  to  pay  the 
claim,  and  it  will  1)e  prima  facie  evidence  of  the  amount 
that  is  due,  and  puts  on  the  Government  the  burden 

84  Reg,  14  Rev.  The  form  to  be  used  in  claiming  refund  is 
officially  known  as  Form  46, 

85  T,  D,  2443, 

36  Hastings  v.  Herold,  184  Fed.  759. 

87  Edison  Electric  Illuminating  Co,  v,  U,  8,,  38  Ct.  da.  208. 


444  FEDERAL   INCOME   TAX 

of  showing  fraud  or  mistake.^*  Before  a  suit  can  be 
commenced  to  recover  taxes  erroneously  or  illegally 
assessed  or  collected,  or  upon  any  penalty  claimed  to 
have  been  collected  without  authority,  or  for  any  sum 
alleged  to  have  been  excessive  or  in  any  manner  wrong- 
fully collected,  an  appeal  must  be  made  to  and  a  deci- 
sion rendered  by  the  Commissioner  of  Internal  Revenue, 
according  to  the  provisions  of  law  in  that  regard,  and 
the  regulations  of  the  Secretary  of  the  Treasury  estab- 
lished in  pursuance  thereof.  If  such  decision  is  delayed 
more  than  six  months  from  the  date  of  appeal,  the 
suit  may  be  brought  at  any  time  within  the  period  pro- 
vided by  Section  3227,  Revised  Statutes,  without  first 
having  a  decision  of  the  Commissioner.^*  Section  3227 
provides  that  no  suit  to  recover  taxes  wrongfully  col- 
lected may  be  maintained  in  any  court,  unless  it  is 
brought  within  two  years  next  after  the  cause  of  action 
accrued.  Under  Section  3226  no  suit  can  be  maintained 
unless  the  taxpayer  appeals  to  the  Commissioner  of 
Internal  Revenue.  This  appeal  must  be  made  within 
two  years  after  the  cause  of  action  accrued.  The  ac- 
crual of  the  cause  of  action  is  at  the  date  the  tax  is 
illegally  assessed  or  collected.  The  date  when  the  col- 
lector receives  the  money  in  payment  of  the  tax  is 
considered  to  be  the  date  when  the  wrongful  act  is  done 
by  the  United  States.  For  example,  if  a  tax  is  paid 
on  June  28,  1917,  the  claim  for  refund  must  be  filed  on 
or  before  June  28,  1919,  and  suit  may  then  be  com- 
menced not  less  than  six  months  after  filing  the  claim 
for  refund,  and  not  more  than  two  years  after  the  Com- 

38  U.  S.  V.  Real  Estate  Savings  Bank,  104  U.  S.  728 ;  Kaufman 
V.  U.  S.,  96  U.  S.  567. 

39  R.  S.,  §  3226. 


ABATEMENT,    REFUND   AND    RECOVERY   OF   TAXES      445 

missioner  makes  his  decision  on  such  claim  for  refund.*® 
The  claimant  is  not  required  to  bring  suit  within  two 
years  and  six  months  after  filing  the  claim  for  refund, 
but  may,  at  his  election,  await  the  decision  of  the  Com- 
missioner and,  if  adverse,  bring  suit  within  two  years 
thereafter."  The  rejection  of  a  claim,  by  the  Commis- 
sioner of  Internal  Revenue,  must  be  on  the  merits  and 
not  for  irregularity  in  the  form  in  order  to  support 
an  action.**  If  an  imperfect  claim  is  filed  within  two 
years,  it  seems  to  be  within  the  statute,  although  the 
corrected  application  is  not  made  within  that  time, 
and  if  suit  is  brought  within  two  years  after  rejection 
of  the  corrected  claim,  it  is  within  the  statute,  although 
more  than  two  years  have  expired  since  the  first  rejec- 
tion. If  the  application  for  refund  was  filed  more  than 
two  years  after  paying  the  tax,  suit  cannot  be  main- 
tained, and  the  fact  that  the  Commissioner  rendered 
an  adverse  decision  on  the  application,  when  filed,  does 
not  operate  to  extend  the  time.*^ 

Suit  Against  Collectors.  The  collector  who  exacted 
the  tax  may  be  sued  for  the  recovery  thereof,  but  an 
action  thereon  canot  be  commenced  against  his  suc- 
cessor in  office.     The  remedy  lies  in  an  action  against 

40  New  York  Mail  and  Newpaper  Transportation  Co.  v.  Ander- 
son, 234  Fed.  590. 

41  Merck  v.  Treat,  174  Fed.  388;  Cheatham  v.  U.  S.,  92  U.  8.  85; 
Kings  County  Savings  Institution  v.  Blair,  116  U.  S.  200;  Con\- 
missioners  v.  Buckner,  48  Fed.  533;  Christie-Street  Commission 
Co.  V.  U.  S.,  136  Fed.  326,  affirming  129  Fed,  506;  Farrell  v. 
tr.  8.,  167  Fed.  639;  Sehwarzschild  and  Sulsberger  v.  Bucker, 
143  Fed.  656;  Hicks  v.  James'  Administratrix,  48  Fed.  542;  aff'd 
110  U.  S.  272. 

4« Hicks  V.  Administratrix,  48  Fed.  542;  aff'd  110  U.  8.  272. 
43  Public  Service  Ry.  Co.  v.  Harold,  219  Fed.  301. 


446  FEDERAL   INCOME  TAX 

the  collector  to  whom  the  tax  was  paid,  or  in  an  action 
against  the  United  States.**  It  has  been  held  that  an 
action  of  assumpsit  may  be  maintained  against  the  col- 
lector who  actually  exacted  the  tax,  and  such  action 
can  be  revived  against  the  personal  representative  of 
the  deceased  collector.*^  When  once  an  action  has  been 
lawfully  commenced  against  a  collector,  it  does  not 
abate  by  reason  of  the  expiration  of  his  term,  but  in 
such  event  the  court  may,  under  the  express  provisions 
of  the  Act  of  February  8,  1899,*^  allow  the  suit  to  be 
maintained  against  his  successor. 

Suits  Against  the  United  States.  Suit  for  recov- 
ery of  taxes  alleged  to  have  been  wrongfully  assessed 
and  collected  may  be  maintained  directly  against  the 
United  States  under  the  so-called  Tucker  Act.*''  In 
answer  to  the  question,  ''Can  the  plaintiff  bring  suit 
to  recover  taxes,  alleged  to  have  been  wrongfully 
assessed  and  collected  under  the  corporation  tax  law, 
directly  against  the  United  States  under  the  Tucker 
Act,  other  requirements  of  law  having  been  complied 
with,  or  is  its  remedy  against  the  Collector  of  Internal 
Revenue  by  whom  the  assessment  and  collection  were 
made"   it   was  held  that   the  question  was  no   longer 

44  Roberts  v.  Lowe,  236  Fed.  604.  In  this  case  the  court  said 
the  latter  remedy  was  apparently  authorized  by  the  case  of  U.  S. 
V.  Emery,  237  U.  S.  28 ;  35  Sup.  Ct.  499 ;  59  L.  Ed.  825.  As  to 
suing  collector  personally  under  a  state  law  for  damages  in  wrong- 
fully collecting  taxes,  see  Public  Service  Ry.  Co.  v.  Herold,  229 
Fed.  902,  910. 

48  Patton  V.  Brady,  Executrix,  184  U.  S.  608,  22  Sup.  Ct.  493 ; 
46  L.  Ed.  713. 

46  30  Stat.  L.  822,  c.  121. 

47  Judicial  Code  §  24,  ^  20;  Ch.  397,  24  Stat.  635  (U.  S.  Compiled 
Stats,  p.  3635). 


ii 


ABATEMENT,    REFUND   AND   RECOVERY   OP   TAXES      447 

open."  The  Tucker  Act  refers  to  original  suits,  and 
does  not  permit  a  recovery  of  demands  against  the 
United  States  on  counterclaims.*® 

Protest  and  Duress.  In  order  to  maintain  an  action 
for  the  recovery  of  taxes  it  is  necessary  that  the  tax 
shall  have  been  paid  under  protest  and  duress.  For 
a  discussion  of  this  subject  see  the  chapter  on  assess- 
ment and  payment  of  the  tax.*® 

Recovery  of  Interest.  It  is  a  well-settled  principle 
that  the  United  States  are  not  liable  to  pay  interest 
on  claims  against  them,  in  the  absence  of  express  statu- 
tory provision  to  that  effect.  It  has  beel^  established 
as  a  general  rule  in  the  practice  of  the  Government 
that  interest  is  not  allowed  on  claims  against  it,  whether 
such  claims  originate  in  contract  or  in  tort;  whether 
they  arise  in  the  ordinary  business  of  administration, 
or  the  private  acts  of  relief  by  Congress  on  special 
application.  The  only  recognized  exceptions  are  where 
the  Government  stipulates  to  pay  interest,  and  where 
interest  is  given  expressly  by  an  Act  of  Congress,  either 
by  the  name  of  interest,  or  by  that  of  damages.  Not 
only  is  this  the  general  principle  and  settled  rule  of 
the  executive  department  of  the  Government,  but  it 
has  been  the  rule  of  the  Legislative  Department,  be- 
cause Congress,  though  well  knowing  the  rule  observed 
at  the  Treasury,  and  frequently  invited  to  change  it, 
has  refused  to  pass  any  general  law  for  the  allowance 
and  payment  of  interest  on  claims  against  the  Govern- 

4S  Emery,  Bird  Thayer  Realty  Co.  v.  U.  S.,  198  Fed.  242,  citing 
Christie-Street  Commission  Co.  v.  U.  S.,  136  Fed.  326. 
«U.  S.  V.  Nipissing  Mines  Co.,  206  Fed.  431. 
MSee  Chapter  36. 


448  FEDERAL   INCOME  TAX 

ment.**  Where  a  person  accepts  from  the  Government 
without  objection  a  refund  of  a  sum  illegally  exacted 
he  gives  up  his  right  to  sue  for  interest.^''  The  ground 
for  refusal  to  allow  interest  is  the  presumption  that 
the  Government  is  always  ready  and  willing  to  pay 
its  ordinary  debts.  When,  however,  an  illegal  tax  has 
been  collected,  the  citizen  who  has  paid  it,  and  has 
been  obliged  to  bring  suit  against  the  collector,  is  enti- 
tled to  interest  in  the  event  of  recovery  from  the  date 
of  the  illegal  exaction.^^  In  a  case  where  there  had 
been  a  delay  of  thirty  years  in  prosecuting  a  claim  to 
recover  internal  revenue  taxes,  interest  was  not  allowed 
from  the  date  of  payment  of  the  taxes,  but  was  allowed 
frpm  the  time  of  commencing  the  suit.^*  It  seems  clear 
that  in  a  suit  against  a  collector  of  internal  revenue 
interest  may  be  recovered  whether  or  not  the  same 
rule  applies  to  suits  against  the  United  States.^^  On 
recovery  of  a  judgment  against  a  collector  of  internal 
revenue  for  the  amount  of  an  internal  revenue  tax 
illegally  collected,  the  plaintiff  is  entitled  to  have  the 
judgment  state  that  it  is  with  interest,*®  Where  judg- 
ment is  recovered  in  an  action  against  a  collector,  inter- 
est may  be  recovered  up  to  the  time  final  judgment  is 
entered  and  a  certificate  from  the  trial  court  that  there 
was  probable  cause  for  the  collection  of  the  tax  has 
been  given.  Upon  giving  such  certificate  the  claim 
becomes  one  against  the  United  States,  stopping  the 
right  to  further  interest,  unless  a  review  of  the  judg- 
ment by  an  appellate  court  is  obtained,  in  which  event 

61  U.  S.  V.  Bayard,  127  U.  S.  260,  8  Sup.  Ct.  Rep.  1156. 

62  Stewart  v.  Barnes,  153  U.  S.  456. 

63  Erskiiie  v.  Van  Arsdale,  15  Wall.  75. 
64Burrough  v.  Abel,  105  Fed.  366. 

66  Conant  v.  Kinney,  162  Fed.  581. 

68  New  York  Mail  ajid  Newspaper  Transportation  Company  v, 
Anderson,  234  Fed.  590. 


ABATEMENT,    REFUND    AND    RECOVERY    OP   TAXES      449 

flic  judgment  upon  the  mandate  of  the  appellate  court 
will  be  treated  as  a  final  judgment,  to  the  rendition  of 
which  interest  will  be  allowed,  unless  the  plaintiff  unduly 
delays  the  presentation  of  his  claim.'"''  A  suit  against 
a  collector  is  a  private  suit  and  there  is  no  claim  against 
the  Government  until  a  certificate  of  probable  cause, 
under  Section  989,  Revised  Statutes,  has  been  obtained 
from  the  court,  at  which  time  the  Government  assumes 
a  definite  liability  of  the  collector,  which  does  not 
include  the  payment  of  interest  thereafter;  neither  is 
there  any  further  personal  liability  on  the  part  of  the 
collector.  The  interest  which  may  be  recovered  is  that 
put  into  the  judgment  before  there  is  any  certificate 
of  probable  cause,  and  if  none  has  been  put  in,  the 
Government  assumes  no  part  of  the  liability  of  the 
defendant.  The  liability  assumed  by  the  Government 
includes  interest  and  costs  forming  part  of  the  recovery, 
but  does  not  include  interest  after  judgment.** 

Costs.  Section  3220  of  the  Kevised  Statutes  author- 
izes the  Commissioner  of  Internal  Revenue  to  repay 
to  any  collector  or  deputy  collector  the  full  amount  of 
such  sums  of  money  as  may  be  recovered  against  him 
in  any  court,  for  any  internal  taxes  collected  by  him, 
with  the  cost  and  expenses  of  suit;  also  all  damages 
and  costs  recovered  against  any  collector,  deputy  col- 
lector, or  inspector,  in  any  suit  brought  against  him 
by  reason  of  anything  done  in  the  due  performance  of 
his  oflficial  duty.  Under  this  section  costs  may  be  recov- 
ered against  the  collector.*®  Judgment  is  usually  given 
in  the  District  Court  for  costs  and  interest. 

»7  Klock  Produce  Co,  v.  Hartson,  212  Fed.  758. 

M  White  V,  Arthur,  10  Fed,  80, 

MDe  Bary  v.  Carter,  102  Fed.   130.     However,  see  Treat  v. 
Fanners  Loan  and  Trust  Company,  185  Fed,  760,  763,  ns  to  cost* 
in  the  Sapreme  Court  and  Circuit  Court  of  AppMUa. 
P.  I.  Tax.— 20 


CHAPTER  40 

INFORMATION  AT  THE  SOURCE 

A  uew  administrative  provision  added  to  the  1916 
Law  ^  requires  that  information  be  furnished  by  brokers 
as  to  their  customers,  by  corporations  as  to  dividend 
payments  and  interest  payments,  by  first  collection 
agencies  as  to  foreign  items,  and  by  persons,  corpora- 
tions and  partnerships  generally  as  to  payments  of 
income  to  others,  in  order  that  the  Treasury  Depart- 
ment may  have  data  on  which  to  audit  the  returns  of 
annual  net  income.  Rulings  and  regulations  applying 
these  provisions  have  not  been  issued  at  the  time  of 
this  writing.  The  several  classes  of  payments  which 
are  required  to  be  reported,  and  the  provisions  with 
respect  to  each,  are  discussed  in  the  following  para- 
graphs. 

Miscellaneous  Income,  Gains  and  Profits.  Payments 
of  interest,  rent,  salaries,  wages,  premiums,  annuities, 
compensation,  remuneration,  emoluments,  or  other  fixed 
or  determinable  gains,  profits  and  income  of  $800  or 
more  in  any  taxable  year  must  be  reported.  "Fixed 
or  determinable  gains,  profits  and  income"  as  used  in 
this  section  would  seem  to  include  payments  of  all  the 
kinds  expressly  enumerated  and  all  payments  of  a  simi- 

1  Act  of  September  8,  1916,  §§  26,  27  and  28,  added  by  Act  of 
October  3,  1917. 

450 


INFORMATION   AT  THE   SOURCE  451 

lar  kind  or  nature.  In  the  case  of  collection  at  the 
source  the  payments  must  be  annual  or  periodical,  while 
in  the  case  of  information  at  the  source  the  law  does 
not  contain  such  limitation.  Hence  any  payments  of 
the  kind  described,  whether  made  in  isolated  cases  or 
from  time  to  time,  must  be  reported.  It  is  immaterial 
whether  or  not  an  employee  is  employed  for  the  full  year 
or  his  wages  are  fixed  in  advance  or  paid  according 
to  the  amount  of  work  he  does.*  The  only  exception 
is  in  the  case  of  payments  which  do  not  amount  to 
$800  or  more  in  any  taxable  year.  If  the  aggregate 
of  several  payments  made  to  the  same  payee  equals  or 
exceeds  $800  in  any  taxable  year  the  gross  amount 
should  be  reported.  The  payments  may  be  from  differ- 
ent forms  of  income,  as,  for  instance,  from  interest  and 
rent,  or  interest  and  salary.  In  such  cases,  it  seems, 
the  total  is  required  by  law  to  be  reported,  if  the  aggre- 
gate of  all  payments  in  the  year  to  the  same  payee  equal 
or  exceed  $800.  The  income  required  to  be  reported 
under  this  provision  of  the  law  and  subject  to  the 
minimum  limitation  of  $800  does  not  include  any  of 
the  classes  of  income  specifically  required  to  be  reported 
as  indicated  in  the  following  paragraphs.' 

Gains  and  Losses  of  Customers  of  Brokers.  Every 
person,  corporation,  partnership  or  association,  doing 
business  as  a  broker  on  any  exchange  or  board  of  trade 
or  other  similar  place  of  business,  is  required  to  dis- 
close to  the  Commissioner  of  Internal  Revenue  the 
names  of  customers  for  whom  such  broker  has  trans- 

« Letter  from   Treasury  Department  dated  October  25,   1917; 
I.  T.  S.  1917,  t  2470. 
*  Act  of  S<>pt<»mbpr  8,  1916,  (  28,  added  by  Act  of  October  3, 


452  FEDERAL   INCOME  TAX 

acted  any  business,  with  such  details  as  to  the  profits, 
losses,  or  other  information  which  the  Commissioner 
may  require,  as  to  each  of  such  customers.* 

Dividends  on  Stock  of  Taxable  Corporations.  Every 
corporation  subject  to  the  tax  imposed  by  the  1916  Law 
is  required  to  disclose  its  payments  of  dividends, 
whether  made  in  cash,  or  its  equivalent,  or  in  stock, 
including  the  names  and  addresses  of  stockholders  and 
the  number  of  shares  owned  by  each,  and  the  tax  years 
and  the  applicable  amounts  in  which  such  dividends 
were  earned.* 

Dividends  on  Stock  of  Foreign  Corporations.     It 

seems  that  the  law  contemplates  that  if  the  foreign 
corporation  is  a  "resident"  corporation,  subject  to  the 
tax  imposed  by  the  1916  Law,  having  an  office  or  place 
of  business  in  this  country,  and  paying  its  dividends 
from  such  office  in  this  country,  it  shall  report  its  divi- 
dend payments  in  the  same  manner  as  indicated  in  the 
preceding  paragraph.  When  dividends  from  stock  of 
foreign  corporations  are  not  payable  in  the  United 
States  the  duty  of  reporting  the  name  of  the  payee 
falls  upon  the  first  collection  agency  collecting  such 
foreign  payment.® 

Interest  on  the  Obligations  of  Domestic  Corporations. 

In  the  case  of  payments  of  interest  upon  bonds  and 
mortgages  or  deeds  of  trust  or  other  similar  obligations 
of  corporations  the  name  of  the  payee  is  to  be  reported 
regardless  of  the  amount  of  interest  paid.'' 

4ld.  §27. 

Bid.  §26. 

6  Id.  §28. 

7  Id.  §28. 


INFORMATION    AT  THE   SOURCE  453 

Interest  on  Obligations  of  Foreign   Corporations. 

Where  interest  is  paid  on  the  obligations  of  foreign 
corporations  from  an  office  in  this  country,  the  intent 
of  the  law  seems  to  be  that  the  corporation,  or  its  pay- 
ing agent,  shall  report  each  payment.  If  such  interest 
is  not  payable  in  the  United  States  the  first  collection 
agency  collecting  the  same  is  required  to  report  the 
payment.® 

Interest  on  Bonds  of  Foreign  Countries.  If  interest 
on  the  bonds  of  foreign  countries  is  paid  in  this  country 
it  seems  that  the  paying  agent  of  the  foreign  country  is 
required  to  report  each  payment,  regardless  of  the 
amount  thereof.  It  is  likely  the  names  of  non-resident 
alien  payees  will  not  be  required,  as  such  information 
would  not  be  necessary  to  effectuate  the  law.  If  such 
interest  is  not  payable  in  the  United  States  the  first 
collection  agency  in  this  country  is  required  to  report 
each  payment,  regardless  of  the  amount  thereof.® 

Interest  on  Obligations  of  the  United  States.  The 
law  expressly  provides  that  no  information  at  the  source 
is  required  in  the  case  of  payment  of  interest  on  obliga- 
tions of  the  United  States.** 

State  and  Municipal  Bonds.  Although  the  interest 
received  from  state  and  municipal  bonds  is  not  subject 
to  tax,  the  law  does  not  expressly  exempt  such  pay- 
ments from  the  requirements  as  to  information  at  the 
source;  neither  does  it  expressly  include  such  payments. 
Procedure  in  this  respect  will  depend  upon  rulings  of 
the  Treasury  Department. 

«Id.  8  28. 
•  Id.  8  28. 
10  Id.  8  28. 


454  FEDERAL   INCOME  TAX 

Procedure  in  Paying  Income.  In  order  that  the 
payor  of  the  income  required  by  the  law  to  be  reported, 
may  obtain  the  necessary  information  the  law  expressly 
provides,  except  in  the  case  of  reports  of  dividend  pay- 
ments and  reports  by  brokers,  that  the  name  and  ad- 
dress of  the  recipient  of  income  shall  be  furnished  upon 
demand  to  the  person,  corporation,  or  partnership  pay- 
ing income.  No  form  of  certificate  to  be  used  for  this 
purpose  has  been  prescribed  at  the  present  writing.  All 
payers  of  income  should  obtain  in  some  form  the  name 
and  address  of  the  recipient  of  such  payment.  It  does 
not  seem  necessarily  that  the  name  of  the  owner  of 
the  income  be  obtained,  as  the  law  merely  requires  that 
the  payor  shall  report  the  amount  of  the  gains,  profits 
and  income  and  the  name  and  address  of  the  recipient 
of  such  payment.^^ 

Return  of  Information  at  the  Source.  The  law  pro- 
vides, with  respect  to  dividend  payments  of  corpora- 
tions, that  the  return  made  by  the  corporation  shall 
state  the  names  and  addresses  of  the  stockholders,  the 
number  of  shares  owned  by  each,  and,  impliedly,  the 
amount  of  dividend  paid  to  each,  during  the  period 
covered  by  the  report,  together  with  information  as 
to  the  tax  years  and  the  applicable  amounts  in  which 
such  dividends  were  earned.  With  respect  to  the  return 
to  be  made  by  brokers,  the  law  provides  that  it  shall 
state  the  names  of  customers  (and  impliedly  their 
addresses)  for  whom  such  broker  has  transacted  any 
business,  with  such  details  as  to  profits,  losses,  or  other 
information  which  the  Commissioner  may  require,  as 
to  each  of  such  customers.  In  the  case  of  all  other 
payments  the  law  requires  the  name  and   address  of 


11  Id.  §28. 


I 


INFORMATION    AT  THE   SOURCE  465 

the  recipient  of  the  payment  and  the  amount  of  the 
gains,  profits  and  income  paid  to  him. 

When  Due.  The  law  specifies  no  time  for  the  filing 
of  this  return,  but  provides  that  the  return  shall  be 
made  in  all  cases  when  required  by  the  Commissioner 
of  Internal  Revenue,  under  such  rules  and  regulations, 
and  in  such  form  and  meinner  as  may  be  prescribed 
by  him,  with  the  approval  of  the  Secretary  of  the 
Treasury. 

Where  Filed.  The  act  does  not  specify  where  such 
return  shall  be  filed.  Forthcoming  regulations  on  the 
subject  will  state  whether 'the  return  is  to  be  filed  with 
local  collector  or  with  the  Commissioner  of  Internal 
Revenue. 

Collection  of  Foreign  Payments.  Where  foreign  pay- 
ments of  interest  upon  the  bonds  of  foreign  countries 
and  interest  from  the  bonds  and  dividends  from  the 
stock  of  foreign  corporations,  are  made  to  residents  of 
this  country,  individuals,  partnerships  or  corporations, 
the  first  collection  agency  in  this  country  is  required 
to  report  the  name  and  address  of  the  recipient  of 
.such  payment  and  the  amount  thereof.  "First  collec- 
tion agency"  as  used  in  this  chapter  means  the  person, 
corporation  or  partnership,  undertaking  as  a  matter  of 
business  or  for  profit,  the  collection  of  foreign  payments 
of  such  interest  or  dividends  by  means  of  coupons, 
checks  or  bills  of  exchange.^*  The  law  provides  that 
"all  persons,  corporations,  partnerships,  or  associations, 
undertaking  as  a  matter  of  business  or  for  profit  the 
collection  of  foreign  payments  of  interest  or  dividends 

"Id.  8  28. 


456  FEDERAL   INCOME  TAX 

by  means  of  coupons,  checks,  or  bills  of  exchange  shal 
obtain  a  license  from  the  Commissioner  of  Interna 
Revenue,  and  shall  be  subject  to  such  regulation! 
enabling  the  Government  to  obtain  the  informatioi 
required  under  this  title,  as  the  Commissioner  of  In 
ternal  Revenue,  with  the  approval  of  the  Secretary 
of  the  Treasury,  shall  prescribe;  and  whoever  know 
ingly  undertakes  to  collect  such  payments  as  aforesaic 
without  having  obtained  a  license  therefor,  or  withou 
complying  with  such  regulations,  shall  be  deemed  t( 
be  guilty  of  a  misdemeanor  and  for  each  offense  b( 
fined  in  a  sum  not  exceeding  $5,000,  or  imprisoned  foi 
a  term  not  exceeding  one  year,  or  both,  in  the  discretioi 
of  the  court.  "^^ 

License.  Application  for  license  for  the  collection  oj 
foreign  items  should  be  made  to  the  collector  of  th( 
district  in  which  the  business  is  to  be  carried  on.  Upor 
the  acceptance  of  such  application  the  collector  wil 
issue  to  the  applicant,  without  cost,  a  license  whicl 
will  continue  in  force  until  revoked  or  cancelled.** 

13  Act  of  September  8,  1916,  §9  (f),  as  amended  by  Act  of 
October  3,  1917. 

14  Reg.  3.3,  Art.  55. 


CHAPTER  41 

COLLECTION   OP  TAX   AT  THE  SOURCE 

Before  the  Amendment  of  October  3,  1917,  the  1916 
Ivaw,  and  the  1913  Law,  required  collection  of  the  tax 
at  the  source  on  payments  of  income  to  citizens  and  resi- 
dents of  the  United  States,  as  well  as  on  payments  to 
noii-wsident  aliens.     The  Amendment  abolished  with- 
holding at  the  source  with  respect  to  citizens  and  resi- 
dents, except  in  the  case  of  the  payment  of  interest  on 
corporate  bonds  containing  covenants  to  pay  the  tax.* 
On  the  payment  of  such  interest  to  individuals,  2%  is 
required  to  be  withheld  at  the  source,  as  more  fully 
explained  in  the  following  paragraphs.    At  the  present 
time  withholding  at  the  source  is  required,  (a)  on  pay- 
ment of  fixed  or  determinable  annual  or  periodical  gains, 
profits  and  income  (except  dividends)  of  any  non-resi- 
dent alien  individual;  (b)  on  payment  of  income  derived 
from  interest  upon  bonds  of  domestic  or  other  resident 
[corporatioiLS  by  non-resident  foreign  corporations  not 
ngaged  in  trade  or  business  in  the  United  States  and  not 
aving  an  oflBce  or  pl^ce  of  business  therein;  (c)  on  pay- 
ent  of  income  derived  from  dividends  on  the  stock  of 
oraestic  or  other  resident  corporations  by  non-resident 
weign  corporations  not  engaged  in  business  or  trade ^ 
eithin  the  United  States  and  not  having  an  office  or  place 

1  Act  of  September  8,  1916,  §  9  (e)  as  amended  by  Act  of  Octo- 
er  3,  1917. 

457 


458  FEDERAL   INCOME  TAX 

of  business  therein  and  (d)  on  payment  of  interest  on 
bonds  of  corporations  to  individuals,  citizens,  residents 
or  aliens,  if  such  bonds,  or  the  mortgages  under  which 
they  are  issued,  contain  a  covenant  to  pay  any  portion 
of  the  income  tax  for  the  bondholder,  or  to  pay  the  inter- 
est without  deduction  for  any  tax  which  the  corporation 
may  be  required  or  permitted  to  pay  thereon  or  retain 
therefrom  under  any  law  of  the  United  States.  The 
Amendment  is  retroactive  to  January  1,  1917,  and  any 
normal  tax  withheld  from  income  paid  to  citizens  or 
residents  in  1917,  other  than  interest  described  in  (d) 
above,  is  required  by  the  law  to  be  released  and  paid 
over  to  the  persons  from  whose  income  such  tax  was 
withheld. 

Definitions.  In  order  to  clarify  the  discussion  in  this 
chapter,  the  following  words  and  phrases  will  be  used  in 
the  sense  defined,  unless  otherwise  indicated  in  the  text. 

Fixed  or  Determinable  Income.  The  phrase  as  used 
in  the  law  includes  interest,  rent,  salaries,  wages,  pre- 
miums, annuities,  compensation,  remuneration,  emolu- 
ments, or  other  fixed  or  determinable  annual  or  period- 
ical gains,  profits,  and  income,  but  expressly  excludes 
income  derived  from  dividends  on  capital  stock,  or  from 
the  net  earnings  of  a  corporation,  joint  stock  company, 
or  association,  or  insurance  company,  which  is  taxable 
upon  its  net  income.^  Under  the  1913  and  1916  Laws, 
the  Treasury  Department  defined  the  term  in  a  series  of 
regulations,  as  follows :  ^ 

2  Id.  §  9  (b)  as  amended  by  Act  of  October  3,  1917. 

3  Although  the  tax  is  required  to  be  withheld  at  the  source  only 
on  payment  of  fixed  or  determinable  income  of  non-resident  aliensJ 
the  payee  of  other  income  may  be  required  to  account  for  the  taj| 
as  an  agent  for  the  non-resident  principal.    See  Chapter  6. 


COLLECTION   OP  T.UC   AT   THE  SOURCE  459 

Comrnissians.  Where  an  individual  works  on  a  straight 
commission  basis  and,  in  earning  his  commissions,  incurs 
and  personally  pays  traveling  and  other  expenses,  the 
amounts  paid  to  him  as  commissions  are  not  fixed  and 
determinable  income.  If  the  agent  incurs  and  pays  no 
necessary  business  expanses  in  earning  his  commissions, 
the  amount  paid  him  is  fixed  and  determinable  income.* 

Profit  Sharitigs.  The  amount  received  as  a  share  of 
the  profits  of  the  employer  is  fixed  and  determinable  in- 
come.* 

Bonus.  A  bonus  paid  in  addition  to  salary  is  fixed 
and  determinable  income  ®  unless  it  is  a  mere  gift  or 
gratuity. 

Per  Diem  salaries  paid  on  a  straight  basis  of  compen- 
sation for  services  rendered  is  fixed  and  determinable 
income,  unless  the  employee  is  required  by  the  terras  of 
his  employment  or  contract  to  pay  therefrom  his  own 
travel  and  other  legitimate  expenses  incident  to  the  busi- 
ness of  his  employment.'' 

Rent  is  fixed  and  determinable  income  subject  to  with- 
holding, and  this  is  true  whether  payment  is  made  in 
cash  or  in  notes.'  "Where  permanent  improvements  are 
made  by  a  tenant  under  the  t«rms  of  a  lease  the  value 
thereof  is  considered  income  to  the  landlord  to  be  ac- 
counted for  by  the  landlord  as  gain  or  profit  at  the 
termination  of  the  lease,  but  the  amount  is  not  fixed  or 
determinable  income.® 

4  Letter  from  Treasury  Department  dated  January  12,  1917, 
I.  T.  8.  1917.  f  2059 
»T.  D.  2090. 
6T.  D.  2135. 
7T.  D.  21.35. 
8T.  D.  2090. 
»T.  D.  2442. 


460  FEDERAL   INCOME  TAX 

Partnership  Salcuries.  Salaries  stipulated  by  contract 
or  articles  of  agreement  between  partnership  members 
constitute  fixed  and  determinable  income.  But  where, 
by  agreement  or  otherwise,  members  of  the  firm  are  per- 
mitted to  draw  either  stated  or  unstated  sums  in  advance 
of  an  annual  or  periodic  determination  of  partnership 
profits,  no  withholding  is  required,  as  these  sums  do  not 
represent  fixed  or  determinable  income  within  the  mean- 
ing of  the  law.*®  There  is  no  withholding  against  the 
partners  on  payment  of  the  net  distributive  shares  of  the 
income  of  the  partnership. 

When  a  note  is  given  in  payment  of  fixed  and  deter- 
minable income  the  duty  of  withholding  the  tax  is  imposed 
upon  the  maker  of  the  note.** 

Exempt  Income.  Although  exempt  income  may  be 
fixed  and  determinable  no  withholding  is  required  upon 
the  payment  thereof.*'' 

Income  of  an  individual  which  is  not  fixed  or  certain 
and  not  payable  at  stated  periods,  or  is  indefinite  or 
irregular  as  to  amount  or  time  of  accrual,  is  not  subject 
to  withholding  at  the  source,  such  as  incomes  of  farmers, 
merchants,  agents  (unless  the  compensation  is  in  the  form 
of  commissions  as  indicated  above)  lawyers  (ex(5ept  an- 
nual retainers),  doctors,  authors,  inventors,  and  other 
professional  persons  whose  income  is  irregular  or  in- 
definite.** 

Interest  as  a  general  rule  is  held  to  be  fixed  or  deter- 
minable income  and  subject  to  withholding,  but  interest 
paid  by  banks,  bankers,  trust  companies  and  other  bank- 

10  Memorandum  from  Treasury  Department,  I.  T.  S,  1917, 
^  2282.  / 

11  Keg.  33,  Art  68. 

12  T.  D.  1890. 

13  T.  D.  1890  and  T.  D.  2090.    See,  however,  Chapter  6. 


iU 


COLLFXJTION   OP  TAX   AT  THE  SOURCE  461 

ing  institutions  receiving  deposits  of  money  is  not  subject 
to  withholding.^* 

Royalties.  Where  royalties  or  rentals  accrue  under 
the  terms  of  a  lease  or  agreement,  as  for  instance,  royal- 
ties for  the  right  to  mine  or  produce  or  remove  minerals 
or  oil  or  other  natural  deposits,  the  royalty  or  rental  is 
not  fixed  or  determinable  income  if  it  represents  a  partial 
return  of  capital  originally  invested  in  the  lands  by  the 
lessor.'' 

Dividends.  The  term  dividends  as  used  in  this  chapter 
means  dividends,  as  defined  in  the  law  ^®  upon  the  capital 
stock  or  from  the  net  earnings  of  domestic  or  other  resi- 
dent corporations,  joint-stock  companies  or  associations, 
and  insurance  companies.^''  The  term  includes  dividends 
paid  in  cash,  scrip  or  stock. 

Bond  Interest.  The  term  as  used  in  this  chapter 
means  interest  upon  bonds  and  mortgages,  or  deeds  of 
trust  or  similar  obligations  of  domestic  or  other  resident 
corporations,  joint-stock  companies  or  associations,  and 
insurance  companies.**  The  term  does  not  include  inter- 
est payments  on  ordinary  bankable  commercial  paper  of 
corporations  or  ordinary  promissory  notes  of  corpora- 
tions not  exceeding  one  year  in  time.** 

14  Beg.  33,  Art.  67. 

I*  Letter  from  Treasury  Department  dated  March  10,  1916, 
I.  T.  S.  1917,  51 750. 

16  See  Chapter  23. 

HAct  of  September  8,  1916,  813  (f). 

1»  Act  of  September  8,  1916,  §  13  (e)  as  amended  by  Act  of 
October  3,  1917. 

19  T.  D.  2090. 


462  FEDERAL  INCOME  TAX 

Covenants  to  Pay  the  Tax.  The  term  as  used  in  this 
(.chapter  means  a  covenant,  contract  or  provision  in  the 
))onds  or  the  mortgage  or  other  obligations  of  a  corpora- 
tion by  which  the  obligor  agrees  to  pay  any  portion  of  the 
income  tax  imposed  by  the  1916  Law  or  the  1917  Law 
upon  the  obligee,  or  to  reimburse  the  obligee  for  aiay 
portion  of  the  tax,  or  to  pay  the  interest  without  deduc- 
tion for  any  tax  which  the  obligor  may  be  required  or 
permitted  to  pay  thereon  or  to  retain  therefrom  under 
any  law  of  the  United  States.^" 

Domestic  Corporations.  The  term  as  used  in  this 
chapter  means  a  corporation  as  defined  in  Chapter  12 
of  this  book,  that  is,  a  corporation,  joint-stock  company, 
association  or  insurance  company  organized  in  the 
United  States. 

Resident  Corporations.  The  law  refers  to  domestic 
"or  other  resident  corporations"  ^^  but  does  not  define 
the  term.  As  used  in  this  chapter  it  means  a  corporation, 
joint-stock  company,  association  or  insurance  company 
organized  under  a  foreign  jurisdiction  and  having  a  place 
of  business  in  this  country,  from  which  interest  on  its 
bonds  and  dividends  on  its  stock  are  paid.^^. 

20  Act  of  September  8,  1916,  §9  (c)  as  amended  by  Act  of 
October  3,  1917.    See  Chapter  42. 

21  Act  of  September  8,  1916,  §  13,  ^J^J  (e)  and  (f). 

22  It  seems  to  have  been  the  intention  of  Congress  to  apply  the 
provisions  with  respect  to  withholding  to  such  foreign  corporations 
as  are  within  the  jurisdiction  of  the  Federal  Government.  Al- 
though a  foreign  corporation  may  have  one  or  more  branch  offices 
here,  if  interest  on  its  bonds,  or  dividends  on  its  stock,  are  not 
payable  in  the  United  States,  it  does  not  seem  that  the  law  intends 
the  corporation  to  vrithhold  the  tax  at  the  source. 


J 


coIjLECTIon  of  tax  at  the  source  .  463 

Withholding  Agents.  The  term  as  used  in  this  chap- 
ter refers  to  the  individual,  partnership  or  corporation 
required  under  the  provisions  of  the  law  to  withhold  the 
tax  at  the  source  and  to  report  and  pay  over  the  amount 
thereof  to  the  Government.  Corporations  may  appoint 
withholding  and  paying  agents  to  act  for  them  in  collect- 
ing tiie  tax  at  the  source  and  making  the  returns  of  the 
amounts  so  collected  by  filing  a  notice  with  the  local 
collector.** 

Withholding  on  Payment  of  Fixed  or  Determinable 
Income.  The  law  provides  that  the  tax  shall  be  with- 
held at  the  source  upon  payments  of  fixed  or  determinable 
annual  or  periodical  gains,  profits  or  income  of  any  non- 
resident alien.  The  phrase  fixed  or  determinable  income 
is  defined  in  a  preceding  paragraph  of  this  chapter.  It 
should  be  noted  that  the  withholding  provisions  do  not 
apply  unless  the  income  is  not  only  fixed  or  determinable 
but  also  annual  or  periodic.  Although  payments  of  other 
income  to  non-resident  aliens  is  not  subject  to  withhold- 
ing at  the  source,  the  resident  in  this  country  having 
receipt,  control  or  custody  of  such  income  may  be  re- 
<iuired,  as  agent  for  the  non-resident  principal,  to  report 
the  amount  of  such  income  and  to  account  for  the  normal 
tax  and  the  supertax  thereon,  as  indicated  in  a  preceding 
chapter.**  Persons  paying  fixed  or  determinable  income 
to  non-resident  alieiLs  are  authorized  and  required  by  the 
law  to  deduct  and  withhold  such  sums  as  will  be  suffi- 
cient to  pay  the  normal  tax  imposed  thereon  by  the  1916 
Law.**    Xo  normal  tax  is  imposed  on  non-resident  aliens 

M  Reg.  33,  Art.  38. 
«4  See  Chapter  6. 

2*  Act  of  September  8,  1916,  §9  (b)  as  amended  by  Act  of 
October  .•],  1917. 


464  FEDERAL   INCOME  TAX 

by  the  1917  Law.^®  This  means  that  upon  all  payments 
of  income  to  non-resident  aliens  2%  must  be  withheld 
at  the  source  by  the  withholding  agent  and  paid  over 
to  the  Government.  There  is"  no  withholding  at  the 
source  on  payments  of  fixed  or  determinable  income  to 
citizens  or  residents  or  to  corporations  or  partnerships, 
except  as  indicated  in  the  following  paragraphs. 

Withholding  on  Payment  of  Dividends.    The  tax  is 

withheld  on  payment  of  dividends  only  in  cases  where  the 
dividend  is  paid  to  non-resident  foreign  corporations  not 
engaged  in  business  or  trade  within  the  United  States 
and  not  having  any  office  or  place  of  business  therein.^''' 
The  law  requires  the  corporation  paying  the  dividend, 
or  its  paying  agent,  to  withhold  the  tax  of  2%  imposed 
-by  Section  10(a)  of  the  1916  Law.  This  amount  is  to 
be  withheld  regardless  of  the  year  in  which  the  divi- 
dend was  earned  by  the  paying  corporation.**'  It  has 
been  held  by  the  Treasury  Department  that  the  tax  of 
4%  imposed  on  foreign  corporations  by  the  1917  Law  is 
not  to  be  withheld  at  the  source  on  payments  of  divi- 
dends,29  since,  for  the  purpose  of  assessing  the  tax  im- 
l)osed  by  the  1917  Law,  corporations  are  permitted  to 
deduct  from  their  net  incomes  the  amount  of  dividends 
received  from  other  corporations  taxable  under  that 
law.^®  Where  stock,  actually  owned  by  a  non-resident 
foreign  corporation  having  no  office  or  place  of  business 
in  this  country,  stands  on  the  books  of  the  corporation 

26  Act  of  October  3,  1917,  §  1. 

27  Act  of  September  8,  1916,  §13   (f). 

28  T.  D.  2584. 

29  Letter   from    Treasury   Department  dated   October   29,   1917, 
I.  T.  S.  1917,  512469. 

30  Act  of  October  3,  1917,  §  4. 


COLLECTION   OF   TAX   AT   THE  SOUKCE  465 

in  the  name  of  a  nominal  stockholder,  the  paying  corpo- 
ration will  be  required  to  withhold  the  tax  at  the  source 
if  it  Jias  knowledge  of  the  fact  that  the^ actual  owner  is 
such  a  foreign  corporation.'*  Wlien  stock  dividends  are 
paid,  the  Treasury  Department  suggests  that  a  domestic 
corporation  may  protect  itself  by  requiring  the  foreign 
corporation  stockholder  to  deposit  with  it,  prior  to  the 
payment  of  the  stock  dividend,  an  amount  equal  to  the 
tax,  or  to  issue  stock  or  scrip  in  payment  of  the  balance 
due  on  the  stock  after  deducting  the  tax.  In  short,  each 
corporation,  so  far  as  the  law  is  concerned,  must  provide 
its  own  method  for  performing  this  duty.'* 

Withholding  on  Payment  of  Bond  Interest.  The  stat- 
ute rcHiuires  withholding  at  the  source  on  payment  of 
bond  interest  (as  defined  above)  to  non-resident  aliens, 
non-resident  foreign  partnerships  not  engaged  in  busi.- 
lu'ss  or  trade  in  the  United  States  and  not  having  an 
office  or  place  of  business  therein,  and  non-resident  for- 
eign corporations  not  engaged  in  business  or  trade  in  the 
United  States  and  not  having  an  office  or  place  of  busi- 
ness therein.  The  amount  to  be  withheld  at  the  source 
depends  upon  the  status  of  the  owner  of  the  income.  If 
tlie  income  is  owned  by  a  non-resident  alien,  2%  of  the 
payment  is  required  to  be  withheld  at  the  source ;  if  the 
owner  of  the  income  is  a  foreign  partnership  no  tax  need 
be  withheld  at  the  source,*'  if  the  owner  of  the  income 

81  Letter  from  Treasury  Department  dated  October  23,  1917, 
I.  T.  8.  1917,  ^2467. 

32  letter  from  Treasury  Department  dated  April  10,  1917; 
1.  T.  S.  1917,  ^2188. 

33  This  anomaly  is  due  to  the  language  of  S  13  (e)  of  the  1916 
Law,  as  amended  by  the  Act  of  October  3,  1917,  requiring  the 
tax  imposed  by  "subdivision  (a)  of  §  10"  of  the  1916  Law  to  be 
withheld  at  the  source,  which  section  impoees  no  tax  on  partner- 

F.  I.  Tax.— -30 


466  FEDERAL   INCOME  TAX 

is  a  foreign  corporation,  6%  of  the  payment  is  required 
to  be  withheld  ^* 

Interest  on  Bonds  Containing  Covenants  to  Pay 
THE  Tax.  Withholding  is  not  required  on  payment  of 
bond  interest  to  citizens  and  residents,  unless  the  bond, 
mortgage,  deed  of  trust  or  other  similar  obligation  of  the 
corporation  contains  a  contract  or  provision  by  which  the 
corporation  agrees  (a)  to  pay  any  portion  of  the  income 
tax  of  the  creditor  or  (b)  to  reimburse  the  creditor  for 
any  portion  of  the  tax  or  (c)  to  pay  the  interest  without 
deduction  for  any  tax  which  the  corporation  may  be 
required  or  permitted  to  pay  thereon  or  retain  therefrom 
under  any  law  of  the  United  States.^  The  corporation 
is  relieved  from  withholding  only  if  the  person  entitled 
to  receive  such  interest  files  with  it,  on  or  before  Febru- 
arys 1st,  a  signed  notice  in  writing  claiming  the  benefit 
of  the  personal  exemption  under  Section  7  of  the  1916 
Law,3*  The  1917  Law^''  provides  that  the  normal  tax 
imposed  by  that  law  shall  not  be  withheld  under  this 
provision  on  payments  of  interest  made  prior  to  January 

ships.  It  has,  therefore,  been  held  that  income  of  such  partner- 
ships is  not  in  fact  subject  to  withholding  at  the  source.  (Letter 
from  Treasury  Department  dated  October  26,  1917,  I.  T.  S.  1917, 
512468). 

34  T.  D.  2457. 

36  Act  of  September  8,  1916,  §9  (c)  as  amended  by  Act  of 
October  3,  1917.  This  provision  has  been  called  "an  excrescence 
on  the  law."  Its  purpose  seems  not  to  be  so  much  to  assist  the 
Government  in  collecting  the  tax  as  to  shift  the  burden  of  the  taX 
from  the  creditor  to  the  debtor  corporation,  a  burden  the  corpora- 
tion would  not  be  required  to  assume  were  it  not  for  the  require- 
ment that  the  tax  be  withheld  at  the  source. 

36  Act  of  September  8,  1916,  §  9  (c)  as  amended  by  Act  of 
Octoiier  3,  1917. 

37  Act  of  October  3,  1917,  §  3. 


COLLECTION    OF   TAX    AT   THE   SOURCE  467 

1,  1918,  and  that  ou  payments  of  interest  made  after  that 
date  only  one  2%  normal  tax  shall  be  deducted  and 
withheld  under  this  provision,  any  further  normal  tax 
for  which  the  recipient  of  such  income  is  liable,  under 
the  1916  Law  or  the  1917  Law,  being  payable  by  the 
recipient  and  not  by  the  debtor  corporation.  If  the 
covenant  does  not  require  the  corporation  to  pay  the 
tax  imposed  by  the  1916  Law  or  the  1917  Law  for  the 
bondholder,  no  tax  need  be  withheld."'  The  prac- 
tical effect  of  these  provisions  of  the  law  is  that  where  a 
corporation  has  is.sued  bonds  containing  a  covenant  such 
as  described  above,  it  will  be  required  to  go  through 
the  motions  of  withholding  2%  on  all  payments  of  interest 
to  citizens  or  residents,  unless  a  certificate  is  filed  claim- 
ing exemption  from  the  tax  on  such  income.  No  tax  will 
actually  be  withheld,  since  the  interest  will  be  paid  in 
full  under  the  terras  of  the  covenant,  and  the  corpora- 
tion will  pay  the  tax  theoretically  withheld.  The  citizen 
or  resident  receiving  such  income  will  state,  in  his  return 
of  annual  net  income,  that  a  normal  tax  of  2%  has  been 
withheld  at  the  source,  and  the  tax  assessed  against  him 
will  be  reduced  to  that  extent.  Upon  payments  of  such 
interest  to  non-resident  aliens,  the  corporation  will  be 
required  to  withhold  only  2%,  since  the  normal  tax 
under  the  1917  Law  is  not  imposed  on  non-resident 
aliens.  If  the  owner  of  the  bond  is  a  non-resident  foreign 
corporation  having  no  office  or  place  of  business  in  this 
country,  the  Treasury  Department  requires  6%  to  be 
withheld  at  the  source,  and  the  paying  corporation  will 
consequently  assume  the  burden  of  a  tax  of  6%  on  all 
such  payments.  If  a  citizen  or  resident  is  not  subject  to 
the  income  tax  by  reason  of  the  personal  exemption  to 

37«  Letter  from  Treasury  Department  dated  November  21,  1917; 
I.  T.  S.  1917,12511. 


468  FEDERAL   INCOME  TAX 

which  he  is  entitled,  he  should  file,  on  or  before  February 
1st  of  the  year  following  that  in  which  the  interest  was 
paid,  a  certificate  claiming  exemption,  as  otherwise  he, 
will  subject  the  paying  corporation  to  an  expense  of  2% 
of  the  amount  of  interest,  although  no  tax  is  justly  due.^* 
The  normal  tax  required  to  be  withheld  by  this  provision 
of  the  law  is  required  to  be  deducted  only  by  the  debtor 
corporation  and  should  not  be  withheld  by  any  bank  or 
agency  through  which  collection  is  made.^** 

Against  Whom  the  Tax  Is  Withheld.  Although  the 
foregoing  paragraphs  indicate  the  classes  of  taxpayers 
against  whom  the  tax  is  withheld,  the  law  will  be  re-stated 
under  this  heading  for  the  sake  of  convenient  reference. 

Individuals.  The  tax  is  withheld  on  payments  to  non- 
resident aliens  of  fixed  or  determinable  annual  or  periodic 
income,  including  payments  of  bond  interest,  but  not 
including  payments  of  dividends.  The  amount  to  be 
withheld  on  all  payments  to  non-resident  aliens  is  2%. 
The  tax  is  withheld  on  payments  to  citizens  and  residents 

38  In.  good  conscience,  the  bondholder  should  in  all  cases  apply  a 
portion  of  his  personal  exemption  to  his  income  from  interest 
of  the  kind  described  in  this  section,  as  the  personal  exemption 
is,  according  to  the  intent  of  the  law,  applicable  to  his  income  as 
a  wjiole  and  not  to  his  income  from  any  particular  source.  Thus, 
if  one-tenth  of  an  individual's  income  is  from  interest  of  this 
character,  one-tenth  of  his  personal  exemption  should  be  applied 
against  it,  but  it  cannot  be  reasonably  expected  the  average  in- 
dividual will  adopt  this  course  of  procedure  when  the  law  places 
it  within  his  power  to  apply  his  entire  exemption  to  income  from 
other  sources,  and  to  place  upon  the  debtor  corporation  the  burden 
of  his  tax  to  the  extent  of  2  per  cent  upon  the  full  amount  of  inter- 
est on  "tax-exempt"  bonds. 

38a  Letter  from  Treasury  Department  dated  November  13,  1917 ; 
I.  T.  S.  1917,  H  2480. 


COLLECTION  OP  TAX  AT  THE  SOURCE  469 

of  intei'est  on  corporate  bonds  containing  covenants  to 
pay  the  tax,  but  only  to  the  extent  of  2%,  as  indicated  in 
tlie  foregoing  paragraph  on  that  subject. 

Partnerships.  No  tax  is  withheld  upon  payments  to 
partnerships.  Congress  attempted  to  require  the  tax  to 
)je  withlield  upon  payments  of  Iwnd  interest  to  non-resi- 
dent foreign  partnerships  not  engaged  in  business  or 
trade  in  the  United  States  and  not  having  an  office  or 
place  of  business  therein,  but  by  a  defect  in  the  language 
of  the  law  the  present  statute  does  not  impose  such 
requirement.'® 

Corporations.  No  amount  is  withheld  on  payments  to 
tlomestic  corporations  or  to  foreign  corporations  which 
are  engaged  in  business  or  trade  in  the  United  States  or 
have  an  office  or  place  of  business  therein.  The  tax  is 
withheld  on  payments  of  bond  interest  and  dividends  to 
non-resident  foreign  corporations  not  engaged  in  busi- 
ness or  trade  within  the  United  States  and  not  having  an 
office  or  place  of  business  therein.*®  The  amount  to  be 
withheld  on  payment  of  bond  interest  to  such  foreign 
corporations  is  6%,  and  on  payment  of  dividends,  2%. 

Fiduciaries.  The  tax  is  withheld  upon  payments  to 
fiduciaries  who  are  citizens  or  residents  of  this  country, 
or  who  have  an  office  or  place  of  business  herein,  in  the 
same  manner  and  to  the  same  extent  as  in  the  case  of 
citizens  and  residents.  The  tax  is  withheld  on  payments 
to  foreign  fiduciaries  in  the  same  manner  and  to  the 
same  extent  as   in   the   case  of  non-resident  aliens." 

SS  See  Note  No.  33  of  this  chapter. 
40  See  Page  464. 
«See  Page  468. 


470  FEDERAL  INCOME  TAX 

Fiduciaries  are  subject  to  all  the  provisions  of  the  law 
wliich  apply  to  individuals.*^ 

Agents.  The  fact  that  an  individual,  partnership  or 
corporation  may  have  an  agent  within  this  country  to 
collect  and  receive  income  does  not  operate  to  prevent 
withholding  of  the  tax  on  payments  of  income  to  such 
agent  in  eases  where  payments  of  income  direct  to  the 
principal  would  be  subject  to  withholding.  The  appoint- 
ment of  an  agent  in  this  country  does  not  in  itself  estab- 
lish the  residence  of  the  principal  in  this  country,  for 
purpose  of  the  income  tax,  nor  does  such  appointment 
exempt  the  non-resident  foreign  corporation  from  the 
withholding  provisions  unless,  in  addition  to  the  appoint- 
ment of  the  agent,  the  corporation  is  engaged  in  business 
or  trade  in  this  country  or  has  an  office  or  place  of  busi- 
ness herein.  Agents  of  non-resident  aliens,  or  foreign 
partnerships  or  corporations  subject  to  the  withholding 
provisions  should  proceed,  in  collecting  income  for  their 
principals,  in  the  same  manner  as  the  principals  would 
proceed  if  acting  for  themselves.*^ 

Nominal  Stockholders.  The  tax  is  withheld  on  pay- 
ment of  dividends  of  nominal  stockholders  in  all  cases 
where  the  paying  corporation  knows  the  actual  owner  is 
a  non-resident  foreign  corporation  not  engaged  in  busi- 
ness or  trade  in  the  United  States  and  not  having  an 
office  or  place  of  business  therein.  The  tax  is  also  with- 
held on  payments  of  dividends  to  nominal  stockholders 
who  are  such  foreign  corporations,  regardless  of  who  the 

MAct  of  September  8,  1916,  §8  (c)  as  amended  by  Aet  of 
October  3,  1917. 

43  See  Chapter  6  on  resident  agents. 


I 


COLLECTION   Of  TAX   AT   THE  SOURCE  471 

actual  owner  may  be,  unless  a  certificate  is  filed  with  the 
paying  corporation  disclosing  the  actual  owner.** 

Procedure  in  Collecting  Income.  The  Treasury  De- 
partment has,  at  the  time  of  this  writing,  issued  no 
rulings  governing  the  procedure  in  collecting  income 
from  sources  within  this  country  by  those  against  whom 
the  tax  is  required  to  be  withheld.  No  radical  change 
in  the  system  evolved  under  the  1913  and  1916  Laws  is 
likely,  but  the  number  of  ownership  certificates  will  be 
reduced  and  the  procedure  simplified.  In  the  case  of 
interest  or  other  income  payable  *'to  bearer,"  that  is  to 
the  j)erson  presenting  the  coupons  or  other  evidence 
entitling  him  to  receive  the  income,  a  certificate,  or  cer- 
tificates, will  be  required  disclosing  the  name,  address 
nnd  status  of  the  owner  of  the  income.  The  one  paying 
^uch  income  ^vill  withhold  the  amount  required  by  law 
in  accordance  with  the  facts  revealed  by  such  certificates. 
As  a  non-resident  alien  can  in  no  case  claim  exemption 
from  withholding  at  the  source,  or  prevent  withholding 
by  any  action  on  his  part,  a  certificate  substantially  in 
the  form  now  reciuired  to  be  used  by  non-resident  alien 
individuals,  firms,  organizations  and  fiduciaries**  will 
lie  prescribed.  The  present  form  of  such  ownership 
<'t*rtifieate  is  and  will  be  used  until  the  Treasury  Depart- 
ment issues  new  regulations  on  th«  subjeet. 

()w'NKK.sHip  Cektikicateh.     A  duly  authorized  agent 
may  sign  ownership  and  exemption  certificates  for  his 
j)rincipal,  in  which  case  the  withholding  agent  or  bank 
with  whom  the  certificate  is  filed  must  stamp  or  write' 
on  the  face  of  such  certificate,  "Sati.sfied  as  to  identity 

**See  Clmpter  7  on  nominal  stockholclers. 
MFonn  1004. 


472  FEDERAL   INCOME  TAX 

and  responsibility  of  agent,"  giving  the  name  and  the 
address  of  the  person  so  certifying.  Before  so  certify- 
ing, the  agent  may  be  required  to  furnish  evidence  of 
liis  authority  to  act,  which  will  be  retained  by  the  one 
so  certifying.  Certificates  so  endorsed  may  be  accepted 
by  all  others  through  whose  hands  they  pass,  without 
question  as  to  the  authority  of  the  agent.*^  This  en- 
dorsement is  not  required  when  the  certificate  is  signed 
on  behalf  of  the  owner  by  reputable  banks  or  collecting 
agents  under  the  regulations  providing  therefor.*'' 

Any  one  may  print  the  forms  of  ownership  and  ex- 
emption certificates.  Forms  printed  by  private  parties 
must  conform  in  size,  type,  color  and  weight  to  the  forms 
printed  by  the  Government.**  The  size  is  8  by  3^ 
inches,  reading  from  left  to  right  along  the  8-inch  dimen- 
sion. The  paper  corresponds  in  weight  and  texture  to 
white  writing  paper,  21  by  32,  about  40  pounds  to  the 
ream  of  500  sheets.  The  color  is  yellow  for  certificates 
used  in  claiming  exemption  (Form  1063  and  1071) 
and  white  for  those  used  in  not  claiming  exemption. 
(Form  1004).  Ownership  certificates  to  be  used  by 
foreigners  in  collecting  interest  may  carry,  directly 
under  each  line  of  the  English  text,  a  translation  of  the 
text  in  a  foreign  language.  In  executing  these  certifi- 
cates, however,  all  blanks  to  be  filled  in  with  amounts 
must  be  filled  in  by  using  United  States  dollar  values. 
The  certificates  must  also  be  of  the  same  size  as  those 
carrying  only  the  English  text.*® 

46  Eeg.  33,  Art.  43. 

47  Letter  from  Treasury  Department  dated  April  16,  1914; 
T.  T.  S.  1917,  ^  111. 

48  T.  D.  2325,  T.  D.  2399. 

49  T.  D.  1926. 


COLLECTION   OP   TAX   AT   THE  SOURCE  473 

l\)UM  1004.  This  form  is  used  in  presenting  for 
oUection  or  payment  coupons  detached  from  bonds  and 
other  obligations  of  domestic  corporations  owned  by 
non-resident  alien  individuals,  fiduciaries,  partnerships 
and  corporations.*®  The  form  may  be  used  by  recog- 
nized banks  and  bankers  who  are  authorized  to  act  for 
the  non-resident  owners."^ 

Form  1071.  This  form  may  be  used  by  responsible 
banks  and  bankers,  either  foreign  or  domestic,  for  or  on 
iK'half  of  non-resident  aliens,  in  claiming  exemption 
from  the  tax  on  dividends  from  the  stock  or  interest  on 
the  bonds  of  foreign  corporations,  payable  in  this  coun- 
tj.y  62  This  form  is  primarily  intended  to  be  used  by 
residents,  banks  and  bankers,  acting  on  behalf  of  non- 
resident aliens,  but  where  the  non-resident  alien  acts 
without  the  intervention  of  a  bank  or  banker,  he  may 
^ign  this  form  after  modifying  it  to  show  personal 
wnership  of  the  dividends  or  interest,  as  the  ease  may 
be." 

Substitute  Certificates.  Under  the  1913  and  1916 
Laws  responsible  banks,  bankers  and  collecting  agencies, 
in  this  country  or  in  foreign  countries**  were  permitted 
to  substitute  their  own  certificates  for  the  ownership 

60  T.  D.  2399. 

61  T.  D,  2325.  Until  the  present  law  is  changed  to  require 
withholding  against  foreign  partnerships,  such  organizations  should 
use  Form  1001. 

68  T.  D.  2030,  T.  D.  2325.  An  early  ruling  also  permitted  the 
use  of  Form  1063  by  non-resident  aliens  in  claiming  exemption 
from  income  tax  on  dividends  payable  in  the  United  States  from 
•ook  of  foreign  corporations.     (T.  D.  2012.) 

53  Letter  from  Treasury  Department  dated  June  13,  lOlfi,  T. 
T.  S.  1917,  f  122. 

64  Reg.  33,  Art.  40. 


474  FEDERAL  INCOME  TAX 

certificates  of  the  owners  of  coupons.  The  purpose  of 
making  such  substitution  is  to  prevent  disclosure  of  the 
actual  owner  to  the  various  banks  and  collecting  agents 
through  which  the  coupon  and  its  accompanying  cer- 
tificate might  pass  before  being  finally  presented  to  the 
paying  corporation.  When  the  ownership  certificates 
were  so  detached  they  were  required  to  be  forwarded  to 
the  Commissioner  of  Internal  Revenue,  not  later  than 
the  20th  day  of  the  month  succeeding  that  in  which 
the  coupons  were  thus  received  for  collection.^^  The 
substitution  certificate  *®  recited  that  the  bank  or 
collecting  agent  had  detached  the  ownership  cer- 
tificate from  the  accompanying  coupons,  endorsed 
the  same  as  required  by  the  Treasury  regulations, 
and  would  >forward  such  certificate  to  the  Commissioner 
of  Internal  Revenue  at  Washington,  in  accordance  with 
the  regulations.  The  substitute  certificate  was  thereafter 
handled  as  the  ownership  certificate  would  have  been 
handled,  finally  being  transmitted  to  the  local  collector 
by  the  paying  corporation,  and  by  the  local  collector 
transmitted  to  Washington  where  the  original  ownership 
certificate,  theretofore  sent  to  the  Commissioner,  was 
finally  matched  up  with  the  substitute.  Banks  availing 
themselves  of  the  privilege  of  substituting  their  own 
certificates  were  required  to  keep  a  complete  record  of 
each  transaction  showing  (a)  the  serial  number  of  item 
received,  (b)  date  received,  (c)  name  and  address  of 
person  from  whom  received,  (d)  name  of  debtor  corpora- 
tion, (e)  class  of  bonds  from  which  coupons  were  cut,  (f ) 
face  amount  of  coupons,  (g)  exemption  from  tax,  if  any 
was  claimed  by  the  owner.     Such  substitute  certificates 

55  T.  D.  1903. 

66  Form  1058  was  used  when  exemption  was  claimed  and  Form 
10.59  when  exemption  was  not  claimed. 


COLLECTION    OF   TAX   AT   THE   SOURCE  475 

were  required  to  be  uuuibered  consecutively  and  corre- 
sponding numbers  given  the  original  certificate  detached 
from  the  coupons."  When  the  certificate  of  the  owner 
was  removed  it  was  required  that  an  endorsement  be 
made  thereon,  by  the  collecting  agency  removing  the 
same,  showing  the  number* of  the  ownership  certificate, 
the  name  of  the  collection  agency,  the  date  of  the  cer- 
tificate and  a  statement  that  "the  counterpart  of  the 
within  certificate  was  attached  to  the  coupons  within 
mentioned  for  delivery  to  the  debtor  or  withholding 
agent,  by  whom  the  coupons  are  payable. ' '  *•  Substitute 
certificates  could  be  signed  by  a  fac-simile  rubber  stamp 
providing  proper  authority  was  given  by  the  bank  or 
collecting  agent  to  the  person  using  such  fac-simile  cer- 
tificate and  a  notice  of  such  authorization,  bearing  the 
real  and  fac-simile  signature  of  the  person  so  authorized, 
was  duly  filed  with  the  Commissioner.  The  use  of  sub- 
stitute certificates  has  been  discontinued  as  to  coupons 
presented  for  collection  on  behalf  of  non-resident  aliens, 
corporations  and  partnerships,*® 

Release  of  Amounts  Withheld.  Where  amounts  have 
been  withlield  by  withholding  agents  in  excess  of  the 
tax  liability  of  the  non-resident  alien,  such  non-resident 
alien  may  obtain  a  release  of  the  excess  amounts  withheld 
by  following  the  procedure  indicated  in  the  chapter  on 
non-resident  aliens.®* 

Abatement  and  Refund.  Where  the  withholding 
agent  has  reported  the  amounts  withheld  to  the  Govern- 
ment and  the  tax  has  been  assessed  thereon  abatement 

ft7Reg.  33,  Art.  40. 
MT.  D.  1903. 
6»  T.  D.  2589. 
••  See  p.  56. 


476  FEDERAL   INCOME  TAX 

may  be  claimed,  iu  the  manner  indicated  in  the  chapter 
on  abatement  and  refund,  either  by  the  withholding 
agent  against  whom  the  assessment  was  made  or  by  the 
person  on  account  of  whom  such  taxes  were  withheld.®* 
If  the  tax  has  been  paid  by  the  withholding  agent  refund 
may  be  claimed  as  indicated*in  the  same  chapter.®'' 

By  Whom  the  Tax  Is  Withheld.  The  tax  is  withheld 
by  the  one  paying  the  income  whether  the  payor  be  an 
individual,  a  partnership,  or  a  corporation.  Special  rules 
applying  to  certain  classes  of  withholding  agents  are 
briefly  summarized  below. 

Banks.  Banks,  bankers  and  trust  companies  and 
other  banking  institutions  receiving  deposits  of  money 
are  not  required  to  withhold  the  normal  tax  on  interest 
paid  or  accruing  on  such  deposits,  whether  on  open  ac- 
counts or  on  certificates  of  deposit ;  but  all  such  interest 
whether  paid  or  accrued  must  be  reported  by  the  de- 
positor.®' This  ruling  applies  if  the  depositor  is  a  non- 
resident alien  or  a  foreign  corporation  having  no  office 
or  place  of  business  in  the  United  States.®* 

Corporations.  Corporations  are  required  to  withhold 
the  tax  on  payment  of  any  fixed  or  determinable  income 
to  non-resident  aliens,  on  bond  interest  and  dividends 
paid  to  foreign  corporations  not  engaged  in  business 
or  trade  in  the  United  States  and  not  having  an  office 
or  place  of  business  therein,  and  on  payments  of  interest 
on  bonds  containing  covenants  to  pay  the  tax  to  any 

61  Eeg.  33,  Art.  33. 

62  See  pp.  437  and  440. 

63  Reg.  33,  Art.  67. 

64  Letter  from  Treasury  Department  dated  June  29,  1917,  I. 
T.  S.  1917,  5J2256. 


COLLECTION  OP  TAX  AT  THE  SOURCE       477 

iiulividual  bondholders.  The  amounts  to  be  withheld 
and  the  duties  with  respect  thereto  are  discussed  else- 
where in  this  chapter. 

Debtors.  Resident  debtors  whether  individuals, 
partnerships  or  corporations,  including  mortgagors,  are 
required  to  withhold  the  tax  on  all  payments  of  interest 
to  non-resident  aliens. 

Employers.  Employers  are  required  to  withhold  the 
tax  on  all  salaries,  wages  or  compensation  paid  to  non- 
resident aliens  except  where  the  salary  of  the  non-resi- 
dent alien  is  not  taxable  under  the  law.®* 

FiDUCLVRiES.  Trustees,  executors,  administrators, 
conservators  and  other  fiduciaries  are  required  to  with- 
hold the  tax  on  all  payments  of  fixed  or  determinable 
annual  or  periodic  income  to  non-resident  aliens,  includ- 
ing beneficiaries  of  the  trust  estate  in  their  hands.  For 
discussion  of  the  special  duties  with  respect  to  bene- 
ficiaries see  the  chapter  on  fiduciaries.®® 

Lessors.  Lessors  and  tenants  paying  rent  to  non- 
resident aliens,  or  their  agents,  are  required  to  withhold 
the  tax,  as  rent  is  fixed  or  determinable  income  within 
the  meaning  of  the  law.  In  computing  the  amount  to 
be  withheld  the  les.sor  should  take  into  consideration  such 
•sums,  if  any,  as  are  paid  under  the  terms  of  the  lease, 
as  taxes,  or  other  disbursements,  for  the  landlord.  Thus, 
if  a  tenant  pays  an  annual  rent  of  10,000  in  cash  and  in 
iddition  pays  taxes  of  $1,000,  the  total  amount  on  which 

S&See  Page  48  for  diacussion  of  salaries  paid  to  non-resident 
aliens. 

M  See  Chapter  8. 


478  FEDERAL   INCOME  TAX 

mthholding  should  take  place  is  $11,000.  While  the 
value  of  permanent  improvements  made  on  the  property 
by  the  tenant  is  income  to  the  landlord,  no  withholding 
need  be  made  with  respect  thereto  since  such  income  is 
not  fixed  or  determinable.^ 

Officers  and  Employees  of  the  United  States. 
Officers  and  employees  of  the  United  States  are  required 
to  withhold  the  tax  on  amounts  of  fixed  or  determinable 
income  paid  to  non-resident  aliens. 

Duties  of  Withholding"  Agents.  If  the  withholding 
agent  knows  that  the  one  to  whom  he  pays  fixed  or  de- 
terminable incomes  is  a  person  or  corporation  against 
whom  the  tax  is  required  to  be  withheld,  an  ownership 
certificate  is  not  necessarily  required  from  the  payee, 
but  the  requisite  amount  is  withheld  without  notice  from 
or  to  the  payee.  Where  payment  is  made  to  persons 
not  known  to  the  payee,  as  in  the  case  of  interest  on 
bearer  bonds,  an  ownership  certificate  is  required  from 
each  payee  disclosing  his  or  its  status  and  if  the  payee 
is  one  against  whom  withholding  should  take  place  the 
tax  is  withheld.  If,  in  such  cases,  no  ownership  certifi- 
cate is  presented  the  payee  is  not  required  to  make  pay- 
ment until  the  name  and  address  of  the  recipient  of  the 
income  is  furnished.®' 

On  Payment  of  Registered  Interest.  Corporations 
paying  interest  to  registered  owners  of  bonds  are  not 
required  to  obtain   certificates  of  ownership,  but  will 

«7  See  Page  459. 

68  Act  of  September  8,  1916,  §.28  added  by  Act  of  October  3, 
1917. 


COIJ.ECTION    OK   TAX    AT    THE  SOURCE      •  479 

withhold  the  tax  in  such  cases  where  the  records  of  the 
company  disclose  the  fact  that  the  owner  of  the  bonds 
is  a  person  or  corporation  against  whom  the  tax  is  with- 
held.** The  tax  is  withheld  before  sending  out  orders 
or  checks  for  such  interest  to  the  registered  owners,  and 
the  interest  order  or  check  is  endorsed  with  the  words 
"income  tax  withheld  by  debtor."  An  interest  order  or 
cheek  Ijearing  such  indorsement  may  be  presented  for 
payment  or  collection  without  an  ownership  certificate 
being  attached.''® 

On  Payment  op  Dividends.  Corporations  paying 
dividends  to  non-resident  foreign  corporations,  against 
which  the  tax  is  required  to  be  withheld,  are  not  required 
to  obtain  ownership  certificates,  but  should  withhold  the 
tax  in  all  cases  where  the  records  of  the  corporation  show 
the  stockholder  to  be  a  foreign  corporation  not  engaged 
in  business  or  trade  in  the  United  States  and  not  having 
an  office  or  place  of  business  therein.  If  the  corporation 
has  knowledge  of  who  is  the  actual  owner  of  the  stock, 
it  is  required  to  disregard  the  status  of  the  stockholder 
of  record  and  to  withhold  the  tax  in  cases  where  the 
status  of  the  actual  owner  requires  withholding. 

Monthly  List  Returns.  It  has  heretofore  been  the 
practice  of  the  Treasury  Department  to  require  monthly 
returns  of  the  amounts  withheld  by  (a)  banks  or  col- 
lecting agencies  receiving  coupons  and  interest  orders 
not  accompanied  by  certificates  of  ownera  and  (b)  by 
banks  and  by  corporations  on  payments  of  interest  and 

WT.  D.  1974. 
70  T.  D.  1974. 


480  .  FEDERAL   INCOME  TAX 

dividends.     This  practice  will  be  continued  unless  and 
until  the  Treasury  Department  rules  otherwise.''^^ 

Annual  List  Returns.  The  law  requires  an  annual 
return  to  be  made  on  or  before  March  1st  of  each  year 
of  the  amounts  withheld  during  the  preceding  calendar 
year. 


72 


Disposition  of  Ownership  Certificates.  The  own- 
ership certificates  received  by  the  withholding  agents  are 
filed  with  the  local  collector  at  the  time  of  filing  the  list 
returns.  Withholding  agents  filing  monthly  list  returns 
are  required  to  file  the  ownership  certificates  monthly 
and  those  filing  annual  list  returns  are  required  to  file 

71  The  monthly  list  return  to  be  filed  by  corporations  with  re- 
spect to  payment  of  interest  and  dividends  is  known  as  Form  1012. 
When  the  form  is  used  for  reporting  tax  withheld  on  dividends 
there  should  be  stamped  acjross  the  printed  declaration  at  the  top 
of  the  form,  in  large  letters,  "monthy  return  of  income  tax  with- 
held from  dividend  paid  to  non-resident  alien  eorporatiolis,  etc." 
(T.  D.  2388.)  The  form  used  by  banks  and  collecting  agencies, 
receiving  coupons  not  accompanied  by  certificates  of  the  owners, 
is  Form  1044. 

72  Act  of  September  8,  1916,  §9  (b)  as  amended  by  Act  of 
October  3,  1917.  Heretofore  the  annual  list  return  of  amounts 
withheld  on  payments  of  bond  interest  and  dividends  has  been 
made  on  Form  1013.  (Being  a  summary  of  the  monthly  list 
returns) ;  the  annual  list  return  of  amounts  withheld  on  salaries, 
wages  and  rent,  interest  or  other  fixed  or  determinable  annual 
income  has  been  made  on  Form  1042;  the  annual  list  return  of 
amounts  of  tax  withheld  on  foreign  income  by  licensed  banks  or 
collection  agencies  on  Form  1043a,  and  the  anniial  list  return  of 
amounts  withheld  by  banks  or  collecting  agencies  on  payments  of 
interest  where  coupons  and  interest  orders  were  not  accompanied 
by  certificates  of  owners,  on  Form  1044a.  The  use  of  these  fonns 
will  be  continued,  where  necessary,  until  others  are  prescribed. 


COMiECTIOX   OK   TAX    AT    TIIK   SOliRCE  481 

such  certificates  annually,  in  each  case  accompanying 
the  return. 

Payment  of  Amounts  Withheld  at  the  Source. 
The  withholding  agent  is  required  to  pay  to  the  local 
collector  the  amounts  withheld  at  the  source,  on  or  before 
June  15  of  the  year  following  the  ye^r  in  which  the 
amounts  were  withheld.  The  usual  notice  of  a.ssessment, 
and  notice  and  demand,  is  sent  to  the  withholding  agent 
and  payment  is  made  in  the  same  manner  as  payment  of 
the  tax."'* 

Penalty  for  Failure  to  Withhold  the  Tax.  The  statute 
expressly  provides  that  withholding  agents  are  person- 
ally liable  for  the  tax  which  they  are  required  to  with- 
hold at  the  source.''^*  When  a  withholding  agent,  through 
ignorance  of  his  duties,  or  for  any  other  reason,  has 
failed  to  withhold  the  tax  and  to  make  return,  a  return 
may  be  filed,  upon  discovery  of  his  neglect,  accompanied 
by  a  claim  for  the  abatement  of  such  items  of  tax  as  can 
be  shown  to  have  been  paid  by  the  taxpayers  against 
whom  the  tax  should  have  been  withheld.''* 

73  See  Chapter  36. 

7*  Act  of  September  8,  1916,  $9   (b)   as  amended  by  Act  of 
October  3,  1917. 
76  Mimeograph  letter  No.  1265  to  Collectors. 


P.  I.  Tax.— 31 


CHAPTER  42 

COVENANTS  TO  PAY  TAXES 

Covenants  to  pay  taxes  are  contained  in  bonds,  mort- 
gages, notes,  leases  and  similar  instruments  whereby 
it  is  stipulated  that  the  interest,  rent,  or  other  income 
payable  thereon,  shall  be  paid  without  deduction  for 
taxes.  Many  such  covenants  became  operative  under  the 
1913  and  1916  Laws  by  reason  of  the  requirement  in 
those  laws  that  the  normal  tax  should  be  withheld  at  the 
source.  They  are  operative  under  the  present  law  only 
in  cases  (a)  where  the  payee  of  the  income  is  a  non- 
resident alien  individual,  (b)  in  the  case  of  payments  of 
interest,  on  the  bonds,  mortgages  or  other  obligations  of 
corporations,  to  foreign  corporations  not  engaged  in 
business  or  trade  in  the  United  States  and  not  having 
an  office  or  place  of  business  therein,  and  (c)  in  the  case 
of  payments  of  such  interest  to  citizens  and  residents, 
to  the  extent  that  one  2%  normal  tax  is  required  to  be 
withheld.! 

Since  there  is  a  requirement  in  the  law  that  the  tax 
be  withheld  on  payments  to  citizens  or  residents  in 
cases  where  the  interest  paid  is  upon  bonds  and  mort- 
gages, or  deeds  of  trust  or  other  similar  obligations  of 
corporations  containing  a  contract  or  provision  by  which 
the  obligor  agrees  to  pay  any  portion  of  the  tax  imposed 
l\y  the  law  upon  the  obligee,  or  to  reimburse  the  obligee 

1  See  Chapter  41. 

482  r. 


COVENANTS  TO  PAY   TAXES  483 

for  auy  portion  of  the  tax,  or  to  pay  the  iuterest  with- 
out deduction  for  any  tax  which  the  obligor  may  be 
required  or  permitted  to  pay  thereon  or  to  retain  there- 
from under  any  law  of  the  United  States,  it  becomes  a 
matter  of  importance  to  officers  of  corporations  to  de- 
termine whether  or  not  the  covenants  in  the  bonds  or 
mortgages  of  the  corporation  are  broad  enough  in  gen- 
eral language,  or  specific  enough,  to  require  the  corpora- 
tion to  assume  the  burden  of  the  present  income  tax. 
Unless  there  is  a  legal  obligation  to  pay  the  income  tax, 
or  any  part  thereof  for  the  bondholder,  tlie  officers  of  the 
corporation  may  incur  liability  by  making  such  pay- 
ments, since  if  there  is  no  legal  compulsion,  the  payment 
of  the  tax  of  a  bondholder  is  a  diversion  of  the  funds  of 
the  corporation  to  which  the  stockholders  and  creditors 
may  object  and  for  which  the  officers  may  incur  personal 
liability.  An  examination  of  the  covenant  in  each  bond 
or  mortgage  becomes  essential. 

A  covenant  reading  as  follows  does  not  impose  any 
duty  upon  a  corporation  to  withhold  the  tax  at  the  source 
on  payments  to  citizens  or  residents : 

Both  principal  and  interest  of  this  bond  are  payable 
without  deduction  for  any  taxes,  assessments  or  other 
governmental  charges  which  the  company  may  be  re- 
quired to  pay  thereon  or  authorized  to  retain  therefrom 
under  any  present  or  future  law  or  requirement  of  the 
Ignited  States  of  America  (except  any  Federal  Income 
Tax)  or  any  State,  county,  municipality  or  other  gov- 
ernmental  subdivision   thereof."** 

Many  covenants  to  pay  taxes  were  entered  into  prior 
to  the  enactment  of  the  1913  Law,  and  without  contem- 
plation of  an  income  tax  law  requiring  collection  at 

1»  Letter  from  Treasury  Dpp.nrtment  <latp<1  NovomWr  21.  1917: 
I.  T.  8.  1917,  12511. 


484  FEDERAL   INCOME  TAX 

the  source.  lu  such  covenants  no  specific  reference  is 
made  to  an  income  tax  and  the  force  of  the  covenant 
with  respect  to  the  present  income  tax  depends  upon 
the  general  language  used  therein.  One  typical  form 
reads  as  follows : 

' '  Both  the  principal  and  interest  of  this  bond  are  pay- 
able without  deduction  for  any  tax  or  taxes,  assessment 
or  assessments,  or  other  Governmental  charges,  which 
the  company  may  be  required  or  permitted  to  pay  there- 
on, or  to  retain  therefrom,  under  any  present  or  future 
law  of  the  United  States,  of  of  anv  state,  countv.  munici- 
pality or  other  lawful  taxing  authority  thereof." 

"Whether  this  form  of  covenant  requires  the  corpora- 
tion to  pay  the  income  tax  of  the  bondholder,  or  only 
such  taxes  as  are  imposed  on  the  bond  or  interest,  as  such, 
is  an  unsettled  question.  In  a  recent  case  decided  by  the 
Supreme  Court  of  the  State  of  Arkansas  it  was  held  that 
a  clause  in  bonds  issued  by  a  corporation  promising 
payment  "without  deduction  from  either  such  principal 
or  interest,  for  any  tax  or  taxes,  which  the  Marion  Hotel 
Company  may  be  required  to  pay  or  retain  therefrom, 
under  any  present  or  future  law,  the  Marion  Hotel 
Company  agreeing  to  pay  such  tax  or  taxes,"  did  not 
require  the  corporation  to  pay  the  Federal  income  tax 
of  the  bondholder  which  it  retained  from  the  payment  of 
interest  on  the  bonds,  since  the  tax  is  not  a  tax  on  the 
bond,  but  a  personal  obligation  of  the  bondholder,  aris- 
ing out  of  the  possession  of  an  income  in  excess  of  the 
exemptions  and  deductions  allowed  by  such  law.''    The 

aUrquhart  v.  Marion  Hotel  Company,  194  S.  W.  1.  The  court 
referred  to  the  early  cases  of  Haight  v.  Bailroad  Co.,  6  Wall. 
(73  U.  S.)  15,  18  L.  Ed.  818;  Baltimore  v.  Baltimore  R.  R.,  10 
Wall.  543,  W  L,  Ed.  1043. 


COVENANTS  TO   PAY   TAXES  485 

Supreme  Court  of  Massachusetts  in  deciding  whether  the 
income  tax  came  within  the  terms  of  a  covenant  by  a 
lessee  to  pay  "all  taxes  and  assessments  •  •  ♦  upon 
or  in  respect  of  the  rent  •  •  •  howsoever  and  to 
whomsoever  assessed,"  held  that  the  1913  Law  imposed 
the  tax  "in  respect  of  the  rent"  and  held  that  the  lan- 
guage quoted  was  effective  to  compel  the  tenant  to 
assume  the  tax  of  the  landlord  to  the  extent  that  the 
law  required  the  amounts  thereof  to  be  withheld  at  the 


source.' 

Other  covenants  provide  that  the  debtor  "will  pay 
the  principal  and  interest  of  these  bonds  without  deduc- 
tion for  taxes."  It  is  a  question  whether  or  not  cove- 
nants of  this  kind  are  broad  enough  to  include  taxes  upon 
the  bondholder  as  well  as  taxes  assessed  against  the  cor- 
poration upon  the  mortgage  or  bond  or  interest.  Where 
a  lease  provided  that  the  lessee  should  "pay  all  taxes  and 
assessments — upon  the  yearly  payments  herein  agreed 
to  be  made  by  the  party  of  the  second  part  to  the  party 
of  the  first  part — for  the  payment  or  collection  of  which 
taxes  or  assessments  the  said  party  of  the  first  part 
would  othenvise  be  liable  or  accountable  under  any  law- 
ful authority  whatever;"  and  that  the  lessee  "should 
pay  all  taxes,  charges,  levies,  claims,  liens  and  assess- 
ments of  any  and  every  kind,  which  during  the  contin- 
uance of  the  term  hereby  demised,  shall,  in  pursuance 

3  Suter  V.  Jordan  Marsh  Company,  113  N.  E.  580.  The  court 
seemed  to  rest  its  decision  in  this  case  on  the  conclusion  that  the 
tax  was  levied  uron  the  separate  sources  from  which  a  part  of  the 
net  income  was  derived.  This  conclusion  seems  to  be  contra  to  the 
weight  of  authority  that  the  tax  is  on  the  person  and  not  on  his 
property.  If  such  conclusion  had  been  reached  by  the  court  it 
seems  from  the  opinion  that  the  decision  might  have  been  different. 
See,  however,  Catawissa  R.  R.  Co.  v.  Phila.  &  Reading  Co.,  25o  Pa. 
269. 


486  FEDERAL   INCOME  TAX 

of  any  lawful  authority,  be  assessed  or  imposed  upon 
the  demised  premises,  or  any  part  thereof — all  payments 
recjuired  to  be  made  by  the  party  of  the  first  part  durinj^ 
the  term  of  this  indenture — shall  be  assumed  and  dis- 
ciiarged  by  the  party  of  the  second  part  as  if  the  party 
of  the  second  part  were  primarily  liable  for  same,"  it 
was  held  that  the  lessee  was  liable  for  the  income  tax 
of  the  lessor  on  the  ground  that  it  was  the  apparent  in- 
tention of  the  parties  that  the  lessor  should  receive  the 
amounts  stipulated  as  rent  without  deduction  by  reason 
of  any  tax,  charge  or  assessment  of  any  kind  and  that 
the  language  was  sufficiently  broad  to  cover  the  Federal 
income  tax  although  not  enacted  at  the  time  the  lease  was 
made,*  In  another  case  it  was  held  that  where  a  coven- 
ant provided  that  the  specified  rent  should  be  paid 
''without  any  deduction,  defalcation  or  abatement  for 
any  taxes,  charges  or  assessments  whatsoever,  *  *  * 
it  being  the  express  agreement  of  the  said  parties  that 
the  said  covenantor,  his  heirs  and  assigns,  shall  pay  all 
taxes  whatsoever  that  shall  hereafter  be  laid,  levied  or 
assessed  by  virtue  of  any  law  whatever,  as  well  on  the. 
said  hereby  granted  lot  and  buildings  thereon  erected  or 
to  be  erected  as  on  the  said  yearly  rental  now  charged 
thereon"  it  was  held  that  the  covenant  did  not  impose 
an  obligation  upon  the  lessee  to  pay  the  Federal  income 
tax,  but  that  the  parties  contemplated  a  tax  measured 
by  accumulated  surplus  or  property.^  Again,  where  a 
lease  provided  that  the  lessee  should  "pay  all  taxes, 
charges  and  assessments  *  *  *  imposed  under  any 
existing  or  future  law  on  the  demised  premises,  or  any 

♦  Northern  Pennsylvania  E.  R.  Co.  v.  Philadelphia  &  Reading 
Ry.  Co.,  43  Pa.  C.  C.  150;  aflf'd  249  Pa.  326. 

6  Van  Beil  v.  Brogan,  23  D.  R.  1055  (Dauphin  County  Court, 
Pa.,  1914) . 


COVENANTS  TO  PAY   TAXES  487 

[nivi  thereof,  or  on  the  business  there  carried  on,  or  on 
the  gross  receipts  or  net,  derived  therefrom,  or  upon  the 
capital  stock  of  'the  lessor'  or  the  dividends  thereon,  or 
upon  the  franchises  of  the  said  company,  for  the  pay- 
ment or  collection  of  any  of  which  said  taxes  the  'lessor' 
may  otherwise  be  or  become  liable"  it  was  held  that  the 
lessee  was  not  required  to  pay  the  Federal  income  tax  on 
the  rental  received  by  the  lessor  on  the  ground  that  such 
tax  was  not  expressly  mentioned  and  the  covenant  was 
not  broad  enough  to  discharge  all  liability  for  taxes  of 
every  kind  for  which  the  lessor  should  become  primarily 
liable.* 

The  cases  referred  to  above  are  cases  which  have 
been  decided  under  the  1913  or  1916  Laws.  Other  cases 
arising  under  different  statutes  are  referred  to  in  the 
foot  note."' 

6  Little  Schuylkill  etc.  Co.  v.  Philadelphia  &  Reading  Ry.  Co., 
44  P.  A.  County  Ct.  Rep."  197.  It  seems  in  this  case  the  intuition 
of  the  lessor  was  to  have  the  lessee  pay  any  and  all  taxes  so  that 
the  net  amount  of  the  rental  could  be  distributed  without  diminu- 
tion to  the  stockholders,  but  the  court  held  that  the  language  of 
the  "tovenant  was  not  broad  enough  to  so  hold. 

7  Northern  Trust  Co.  v.  Buck,  263  111.  222,  104  N.  E.  1114. 
Pettibone  v.  Smith,  150  Pa.  118,  24  Atlantic  693;  Chicago  etc.  Ry. 
V.  Kansas  City  N.  W.  R.  R.,  75  Kans.  167,  88  Pac.  1085;  Erie,  etc.. 
R.  R.  V.  Pennsylvania  R.  R.,  208  Pa.  506,  57  Atlantic  980;  Clopton 
V.  Phila.  &  Reading  R.  R.  Co.,  54  Pa,  356;  Northern  Central  R.  R. 
Co,  V.  Jackson,  7  Wall.  262;  U.  S.  v.  Baltimore  &  Ohio  R.  R.  Co.. 
17  Wall.  .'t22.  See  also  article  in  Tllinois  T,:nv  R<>vi('w.  .Tjumary, 
19ir.. 


CHAPTER  43 

CONSTITUTIONALITY  OF  THE  LAW 

It  is  not  the  purpose  of  this  chapter  to  discuss  ex- 
haustively the  constitutional  questions  which  might  exist 
with  respect  to  the  present  laws,  but  to  point  out  certain 
features  of  the  law  with  respect  to  which  questions  of 
constitutionality  have  been  raised. 

Power  of  Congress  to  Levy  Income  Taxes.  The  Six- 
teenth Amendment  to  the  Federal  Constitution  author- 
ized Congress  "to  lay  and  collect  taxes  on  incomes  from 
whatever  source  derived,  without  apportionment."  As 
Chief  Justice  White  has  said,*  this  amendment  does 
not  confer  power  to  levy  income  taxes  in  a  generic  sense 
or  to  limit  and  distinguish  between  one  kind  of  income 
tax  and  another,  but  the  whole  purpose  was  to  relieve 
all  income  taxes,  when  imposed,  from  apportionment; 
in  short,  doing  away  with  the  principle  upon  which 
the  Pollock  case  ^  was  decided.  The  amendment  places 
no  limitation  as  to  the  nature  and  character  of  the  in- 
come taxes  which  it  authorizes.  Congress  derives 
from  the  Constitution^  its  powers  "to  lay  and  collect 
taxes,   duties,    imposts   and   excises."     This   power   is 

1  Brushaber  v.  Union  Pacific  E.  R.  Co.,  240  U.  S.  1. 

2  Pollock  V.  Farmers  Loan  and  Trust  Co.,  157  U.  S.  429;  158 
U.  8.  601. 

8  The  Constitution  of  the  United  States,  Art.  1,  §  8. 

488 

I 


CONSTITUTIONALITY  OF   THE   LAW  489 

exhaustive  and  embraces  every  conceivable  power  of 
taxation,  limited  only  by  the  constitutional  provisions 
that  "all  duties,  imposts  and  excises  shall  be  uniform^ 
throughout  the  United  States,"*  that  "direct  taxes 
shall  be  apportioned  among  the  several  states"*  and 
that  "no  capitation  or  other  direct  tax,  shall  be  laid, 
unless  in  proportion  to  the  census.  * '  ®  The  Sixteenth 
Amendment  removed  the  limitation  but  did  not  enlarge 
the  power  of  Congress. 

Taxing  Gains  and  Profits  from  Sale  of  Property.  The 
decision  in  Gray  v.  Darlington  "^  has  sometimes  been 
mentioned  as  placing  a  limitation  on  the  power  of 
Congress  to  tax  profits  arising  from  the  sale  of  capital 
assets,  on  the  ground  that  the  word  "income"  as  used 
in  the  Sixteenth  Amendment  was  used  in  the  sense  in 
which  it  had  theretofore  been  defined  in  this  case,"'* 
but  the  case  hinged  on  a  consideration  of  the  language 
of  a  particular  act,'  and  did  not  define  the  term  in  any 
general  sense.  The  only  question  before  the  court  was 
to  what  extent  had  Congress  intended  by  that  act  to 
tax  gains  and  profits.  The  court  said  in  part:  "The 
statute  looks,  with  some  exceptions,  for  subjects  of  taxa- 
tion only  to  annual  gains,  profits,  and  income.  Its  gen- 
eral language,  is  'that  there  be  levied,  collected,  and 
paid  annually  upon  the  gains,  profits  and  income  of 
every  person,'  derived  from  certain  specified  sources, 
a  tax  of  five  per  cent.,  and  that  this  tax  shall  be  'assessed, 

4  Id.  Art  1,  §8,  CI.  1. 

6  Id.  Art.  1,  5  2,  CI.  8. 
« Id.  Art.  1,  §  9,  CI.  4. 

7  Gray  v.  Darlington,  15  Wall.  63. 

7«  The  word  mnst  be  presumed  to  have  been  used  in  the  sense  in 
which  the  Supreme  Court  had  theretofore  defined  it  if  a  judicial 
definition  had  been  .clearly  given.    Towne  v.  Eisner,  242  Fed.  702. 

•  Act  of  March  2,  1867. 


490*  FEDERAL   INCOME  TAX 

collected,  and  paid  upon  the  gains,  profits,  and  income 
for  the  year  ending  the  31st  of  December  next  preceding 
the  time  for  levying,  collecting,  and  paying  said  tax. '  ® 
This  language  has  only  one  meaning,  and  that  is  that 
the  assessment,  collection,  and  payment  prescribed  are 
to  be  made  upon  the  annual  products  or  income  of  one's 
property  or  labor,  or  such  gains  or  profits  as  may  be 
realized  from  a  business  transaction  begun  and  completed 
during  the  preceding  year.  There  are  exceptions,  as  al- 
ready intimated,  to  the  general  rule  of  assessment  thus 
prescribed.  One  of  these  exceptions  is  expressed  in  the 
statute,  and  relates  to  profits  upon  sales  of  real  property, 
requiring,  in  the  estimation  of  gains,  the  profits  of  such 
sales  to  be  included  where  the  property  has  been  pur- 
chased, not  only  within  the  preceding  year,  but  within  the 
two  previous  years.  Another  exception  is  implied  from 
the  provision  of  the  statute  which  requires  all  gains,  prof- 
its, and  income  derived  from  any  source  whatever,  in  ad- 
dition to  the  sources  enumerated,  to  be  included  in  the 
estimation  of  the  assessor.  The  estimation  must,  there- 
fore, necessarily  embrace  gains  and  profits  from  trade 
and  commerce,  and  these,  for  their  successful  prosecution, 
often  require  property  to  be  held  over  a  year.  In  the 
estimation  of  gains  of  any  one  year  the  trader  and  mer- 
chant will,  in  consequence,  often  be  compelled  to  include 
the  amouht  received  upon  goods  sold  over  their  cost 
which  were  purchased  in  a  previous  year.  Indeed,  in 
the  estimation  of  the  gains  and  profits  of  a  trading  ot 
commercial  business  for  any  one  year,  the  result  of 
many  transactions  have  generally  to  be  taken  into  accoiint 
which  originated  previously.  Except,  however,  in  these 
and  similar  cases,  and  in  the  cases  of  sales  of  real  prop- 
erty, the  statute  only  applies  to  such  gains,  profits,  and 

914  Stat,  at  Large,  477-8,  §  13. 


CONSTITUTIONALITY  OP   THE  LAW  491 

iucome  as  are  strictly  acquisitions  made  during  the  year 
preceding  that  in  which  the  assessment  is  levied  and 
eoUected."" 

The  facts  in  this  case  were  that  Darlington,  who 
apparently  was  neither  a  merchant  nor  a  trader,  ex- 
changed in  1865  certain  U.  S.  Treasury  notes  for  certain 
U.  S.  bonds.  Two  years  later  the  law  was  enacted,  and 
two  years  after  the  incidence  of  the  tax  (in  1869)  he 
sold  the  bonds  at  a  profit.  The  profit  was  held  by  the 
Treasury  Department  to  be  income  for  the  year  1869. 
The  court  held:  "We  are  satisfied  that  no  such  result 
was  intended  by  the  statute."  Since  this  decision  hinged 
upon  the  language  of  the  statute  its  application  to  the 
present  law  necessitates  a  comparison  of  the  language 
of  the  Act  of  1867  and  the  1916  Law.  The  Act  of  1867 
provided  for  a  tax  upon  the  annual  gains,  profits  and 
income  of  every  person  ''from  any  source  whatever" 
and  further  provided  that  in  estimating  the  gains  and 
profits  and  income,  profits  realized  within  the  year  from 
sales  of  real  estate  purchased  within  the  year  or  within 
two  years  previous  should  be  included  as  well  as  "all 
other  gains,  profits  and  income  derived  from  any  source 
whatever."    The  language  of  the  statutes  enacted  since 

10  In  the  case  of  Oeveland,  C,  C.  and  St.  L.  Ry.  Co.  v.  United 
States,  242  Fed.  18,  the  court  said:  "The  precise  point  decided 
in  Gray  v.  Darlington  was  that  the  accretion  in  value  during  the 
previous  years  were  not  income  for  the  year  in  which  the  prop- 
erty was  sold;  but  doubtless  some  of  the  language  of  the  opinion 
would  indicate  that  such  accretions  were  not  income  even  for  the 
year  in  which  they  happened."  The  language  to  which  the  court 
refers,  however,  seems  to  l>e  dicta  and,  in  the  language  of  the 
opinion  quoted  in  the  text  above,  it  was  intimated  that  the  rule 
as  to  merchants  and  traders  would  be  different  from  the  rule  as 
to  persons  making  isolated  investments,  this  difference  being  due 
to  the  langiiage  of  the  act  and  not  predicated  upon  any  general 
principles. 


492  FEDERAL  INCOME  TAX  . 

the  Sixteenth  Amendment  is  much  broader.  The  tax 
is  imposed  on  ''gains,  profits  and  income  derived  from 
*  *  *  dealings  in  property,  whether  real  or  personal, 
growing  out  of  the  ownership  or  use  of  or  interest  in 
real  or  personal  property"  or  gains  or  profits  and  income 
derived  from  any  source  whatever.  In  the  1916  Law 
there  is  a  provision  which  expressly  prescribes  the 
method  of  computing  the  gain  derived  from  the  sale 
of  assets  acquired  before  March  1,  1913.  There  seems 
to  be  no  doubt  that  Congress  intended  to  tax  profits 
from  any  and  all  sales  of  property,  regardless  of  when 
the  property  was  acquired,  and  it  does  not  seem  that 
there  is  any  want  of  power  to  do  so  under  the  Sixteenth 
Amendment.^^ 

Want  of  Due  Process  of  Law.  The  due  process  clause 
of  the  Fifth  Amendment  to  the  Federal  Constitution 
is  not  a  limitation  upon  the  taxing  power  conferred 
upon  Congress  by  the  Constitution;  in  other  words,  the 
Constitution  does  not  conflict  with  itself  by  conferring 
on  the  one  hand  a  taxing  power  and  taking  the  same 
away  on  the  other  by  the  limitations  of  the  due  process 
clause.  To  make  a  tax  statute  unconstitutional  the 
seeming  exercise  of  the  taxing  power  of  the  act  must 
be  so  arbitrary  as  to  constrain  to  the  conclusion  that 
it  was  not  the  exertion  of  taxation,  but  a  confiscation 
of  property,  that  is,  a  taking  of  the  same  in  violation  of 
the  Fifth  Amendment,  or,  what  is  equivalent  thereto,  was 
so  wanting  in  basis  for  classification  as  to  produce  such  a 
gross  and  patent  inequality  as  to  inevitably  lead  to  the 
same  conclusion.  In  Brushaber  v.  Union  Pacific  R.  R. 
Co.,  the  Supreme  Court,  after  enumerating  a  number  of 
features  of  the  1913  Law  which,  it  had  been  alleged, 

11  Brushaber  v.  Union  Pacific  B.  R.  Co.,  240  U.  S.  1. 


CONSTITUTIONALITY   OF   THE   LAW  493 

constituted  a  violation  of  the  due  process  clause,  dis- 
missed them  by  stating  that  none  in  the  remotest  degree 
presented  such  questions.  The  expediency  of  levying 
a  tax,  or  the  economic  mistake  or  wrong  involved  in 
its  imposition,  is  beyond  judicial  cognizance.^^'  In  an- 
other case  the  court  held  that  the  fact  that  the  tax  was 
levied  on  the  income  of  mining  companies  without  mak- 
ing adequate  allowance  for  depletion  did  not  amount 
to  the  taking  of  property  without  due  process  of  law." 

Uniformity.  The  Constitution  exacts  only  a  geo- 
graphical uniformity  of  taxes  and  a  lack  of  uniformity 
in  other  respects  does  not  make  the  statute  invalid.^* 

Exempting  Certain  Corporations  from  Tax.  The  pro- 
vision of  the  Sixteenth  Amendment  authorizing  a  tax 
on  incomes  "from  whatever  source  derived"  does  not 
require  that  the  tax  must  be  imposed  upon  all  sources 
of  income,  nor  does  it  exclude  the  power  to  exempt 
certain  classes  of  corporations.^* 

Retroactive  Features.  The  right  of  Congress  to  im- 
pose a  tax  by  a  new  statute,  although  the  measure  of 
the  tax  is  governed  by  the  income  of  the  past  year  can- 
not be  doubted;  much  less  can  it  be  doubted  that 
Congress  may  impose  a  tax  on  income  of  the  current 
year,  though  part  of  that  year  has  elapsed  when  the 

n«  Brushaber  v.  Union  Pacific  R.  B.  Co.,  240  U.  S.  1. 

l«  Stnnton  v.  Baltic  Mining  Co.,  240  U.  S.  103. 

ISKnowlton  v.  Moore,  178  U.  8.  41;  Patton  v.  Brady,  184  U.  8. 
608;  Flint  v.  Stone-Tracy  Co.,  220  U.  S.  107;  Billings  v.  United 
States,  232  U.  8.  261;  Brushaber  v.  Union  Pacific  R.  R.  Co.,  240 
U.  S.  1. 

14  Brushaber  v.  Union  Pacific  R.  R.  Co.,  240  U.  8.  1. 


\ 


494  FEDERAL  INCOME  TAX 

statute  is  passed.^**  A  statute  imposing  a  tax  upon  all 
income  of  a  previous  year,  although  one  tax  on  that 
income  has  already  been  paid,  is  valid.^^ 

16  Brushaber  v.  Union  Pacific  E.  R.  Co.,  240  U.  S:  1. 
16  Stockdale  v.  Insurance  Companies,  20  Wall.  323. 


APPENDIX 

CHAPTER  44 

TAX    ON    UNDISTRIBUTED   INCOME   OP  CORPORATIONS 

The  provisions  imposing  this  tax  are  contained  in  and 
are  a  part  of  the  1916  Law  as  amended.*  The  tax  has 
been  sometimes  referred  to  as  a  "supertax  on  corpora- 
tions. ' '  The  purpose  of  the  tax  is  to  counteract  the  tend- 
ency of  corporations  to  permit  their  earnings  to  accumu- 
late as  surplus,  which  action,  although  not  taken  with 
the  intent  of  evading  the  supertaxes,  would,  nevertheless, 
operate  to  reduce  the  supertaxes  paid  by  individual 
stockholdei's.  Under  this  provision  of  the  law  a  corpo- 
ration may  retain  any  part  or  all  of  its  earnings  for  the 
year,  provided  it  is  willing  to  pay  a  tax  of  10%  upon 
such  portion  thereof  as  is  not  actually  invested  and  em- 
ployed in  the  business,  retained  for  employment  in  the 
reasonable  requirements  of  the  business,  or  invested  in 
obligations  of  the  United  States  issued  after  September 
1.  1917.  Of  course,  if  the  earnings  of  the  corporation 
are  accumulated  with  a  fraudulent  purpose  or  intent 
of  preventing  the  imposition  of  the  supertaxes  on  the 
stockholders,  such  stockholders  will  be  taxed  as  though 
the  earnings  had  been  distributed.*  The  provision  im- 
posing thi.s  tax  is  not  intended  to  take  the  place  of  the 
provision  contained  in  Section  3  of  the  1916  Law,  but  is 

1  Act  of  September  8,  1916,  S  10  (b),  added  by  Act  of  October 
:.  1917. 

2  See  Chapter  2. 

495 


k 


496  iVPPENDEt 

intended  to  operate  in  cases  where  the  annual  net  income 
is  retained  beyond  the  reasonable  requirements  of  the 
business  of  the  corporation  and  yet  not  with  fraudulent 
intent  to  avoid  the  imposition  of  the  supertaxes  on  the 
stockholders  of  the  corporation. 

Corporations  Subject  to  the  Tax.  The  law  provides 
that  the  tax  shall  apply  to  ''every  corporation,  joint- 
stock  company  or  association  or  insurance  company." 
This  language,  however,  can  hardly  be  construed  to  mean 
every  corporation  which  derives  any  income  from  sources 
within  the  United  States,  since  such  income  is  derived 
by  foreign  corporations  over  which  this  Government 
would  not  have  sufficient  jurisdiction  to  impose  a  tax 
of  this  character.  The  tax,  undoubtedly,  applies  to 
every  domestic  corporation  and  to  such  foreign  corpo- 
rations as  have  their  principal  office  or  place  of  business 
in  the  United  States,  that  is,  the  class  of  corporations, 
somewhat  indefinitely  referred  to  in  the  1916  Law  as 
"resident  corporations."  The  line  between  foreign 
corporations  which  are,  and  those  which  are  not,  subject 
to  this  tax  might  be  drawn  with  reference  to  the  taxabil- 
ity of  the  non-resident  alien  stockholders  of  the  corpora- 
tion on  dividends  received  from  the  corporation.  Thus, 
if  the  Government  has  no  jurisdiction  to  tax  the  stock- 
holders on  their  dividends  its  would  seem  to  have  no  ju- 
ri.sdictiou  to  impose  this  tax  on  tlie  undistributed  income 
of  the  corporation. 

Undistributed  Net  Income.  The  undistributed  net 
income  referred  to  in  this  provision  of  the  law  is  the 
income  for  the  taxable  year,  either  the  calendar  year  or 
the  fiscal  year  as  the  case  may  be.  The  first  year  for 
which  the  tax  is  imposed  is  the  calendar  year  1917  or,  if 

i 


TAX  ON  UNDISTRIBUTED  INCOME  OP  CORPOIL^TIONS     497 

the  corporation  has  elected  to  report  its  net  income  for 
the  fiscal  year,  the  fiscal  year  ending  in  1917;  in  the 
latter  case,  however,  the  tax  applies  only  to  the  propor- 
tion of  the  taxable  undistributed  net  income  for  such 
fiscal  year  as  the  period  between  January  1, 1917,  and  the 
end  of  the  fiscal  year  bears  to  the  whole  of  sucli  fiscal 
year.  For  example,  if  the  fiscal  year  of  a  corporation 
ends  on  the  30th  day  of  June,  1917,  and  its  taxable  undis- 
tributed income  for  that  fiscal  year  is  $50,000  only  one 
half  thereof  or  $25,000  will  be  taxable,  since  only  one 
half  of  the  fiscal  year  is  in  the  calendar  year  1917.  This 
provision  of  the  law  has  no  reference  to  the  income, 
profits  or  surplus  earned  or  accumulated  by  the  corpora- 
tion prior  to  January  1,  1917,  whether  or  not  such 
income,  profits  or  surplus  is  employed  in  the  business. 
The  fact  that  surplus  accumulated  prior  to  January  1, 
1917,  may  not  be  employed  in  the  business  or  retained  for 
the  reasonable  requirements  of  the  business,  may,  how- 
ever, have  a  bearing  upon  the  taxability  of  the  income  for 
the  current  year,  since  it  would  be  difficult  to  earmark 
the  current  income  and  employ  it  in  business  while  sur- 
plus previously  accrued  is  not  so  employed.  "Within 
the  meaning  of  this  provision  of  the  law,  the  net  income 
for  the  current  year  is  distributed  only  when  paid  to 
the  stockholders  as  dividends.  Another  provision  of  the 
law,  respecting  dividends,'  deems  such  dividends  to  have 
been  paid  out  of  the  most  recently  accumulated  undi- 
vided profits  or  .surplus.  Hence,  any  dividends  declared 
within  six  months  after  the  close  of  a  calendar  year  or 
fiscal  year  may  be  considered  as  a  distribution  of  the 
income  of  such  preceding  year,  unless  the  books  of  a 

8  Act  of  September  8,  1916,  « .31  (b),  added  by  Act  of  October 
•<.  1917. 

F.  I.  Tax.— 32 


498  APPENDIX 

corporation  have  been  closed  withift  the  six  months  and 
earnings  of  the  current  year  have  been  credited  to  sur- 
plus or  undivided  profits.  The  difference  between  the 
amount  of  net  income  reported  by  the  corporation  in  its 
return  of  annual  net  income  and  the  amount  thereof  dis- 
tributed by  the  corporation  at  any  time  before  the  ex- 
piration of  six  months  after  the  end  of  its  fiscal  or  calen- 
dar year,  constitutes  the  undistributed  net  income  which 
this  provision  of  the  law  seeks  to  tax.  From  such 
amount  of  undistributed  net  income  may  be  deducted 
(a)  the  amount  of  any  income  taxes  paid  by  the  corpo- 
ration within  the  taxable  year  imposed  by  authority  of 
the  United  States;  (b)  that  portion  of  such  undistrib- 
uted net  income  which  is  actually  invested  and  employed 
in  the  business  or;  (c)  is  retained  for  employment  in 
the  reasonable  requirements  of  the  business,  or  (d)  is 
invested  in  obligations  of  the  United  States  issued  aft-er 
September  1st,  1917.* 

Income  Taxes  Paid  Within  the  Year.  For  the  pur- 
pose of  determining  the  net  income  subject  to  the  income 
tax  a  corporation  is  not  permitted  to  deduct  the  amount 
of  the  Federal  income  taxes  paid  within  the  year,  but 
such  amounts  may  be  deducted  for  the  purpose  of  this 
tax.  Excess  profits  taxes  paid  during  the  year  are  not 
deductible  for  the  purpose  of  this  tax  since  the  net  in- 
come subject  to  this  tax  is  the  same  as  that  determined 
for  the  purpose  of  the  tax  imposed  by  Subdivision  10a 
of  the  1916  Law,  which  is  the  income  remaining  after  the 
Commissioner  of  Internal  Revenue  has  deducted  the 
amount  of  excess  profits  taxes  assessed  against  the  cor- 

4  Act  of  September  8,  1916,  §  10  (b)  added  hj  Act  of  October 
3,  1917. 


TAX  ON  UNDISTRIBUTED  INCOME  OP  CORPORATIONS     499 

poratiou  in  the  same  year.  As  an  illustration,  if  a  cor- 
poration has  a  net  income  of  $100,000  for  the  year  1917 
and  the  war  excess  profits  tax  assessed  against  it,  on  such 
income,  is  $20,000,  the  income  tax  for  1917  will  be 
assessed  upon  the  remainder  of  the  net  income  after  de- 
ducting the  .amount  of  $20,000,  that  is,  on  $80,000. 
From  the  sum  of  $80,000  the  corporation  may  further 
deduct  the  amount  of  Federal  income  taxes  assessed 
against  it  for  the  year  1916,  and  paid  by  it  in  the  year 
1917,  (not  the  income  tax  assessed  against  it  for  the  year 
1917,  since  such  tax  is  not  paid  until  the  year  1918). 
From  the  net  amount  so  obtained,  it  may  deduct  the 
amount  of  undistributed  net  income  employed  or  invested 
as  indicated  in  the  three  following  paragraphs. 

Net  Income  Actually  Invested  and  Employed  in 
THE  Business.  The  amount  of  undistributed  net  income 
for  the  taxable  year  which  is  actually  invested  or  em- 
ployed in  the  business  is  not  taxable.  Under  this  head 
should  be  included  only  such  earnings  as  have  been 
actually  and  permanently  invested  or  employed  within 
the  taxable  year  or  within  six  months  after  the  end  of 
such  year. 

Net  Income  Retained  fob  Employment  in  the 
Reasonable  Requirements  op  the  Business.  This  de- 
duction differs  materially  from  the  one  referred  to  in 
the  preceding  paragraph.  It  is  not  required  that  the 
undistributed  net  income  shall  be  actually  used  or  em- 
ployed in  the  business  before  the  expiration  of  six 
months  after  the  end  of  the  taxable  year,  but  it  is  suf- 
ficient if  such  income  has  been  retained  for  employment 
in  the  reasonable  requirements  of  the  business.  The 
" rea.wnable  requirements  of  the  business"  will  bo  for 


500  APPENDIX 

practical  purposes  what  the  Treasury  Department  con- 
strues the  phrase  to  mean.  It  is  not  unlikely  that  the 
term  will  be  given  a  very  narrow  construction  in  the 
first  and  general  rulings,  leaving  a  more  liberal  construc- 
tion to  be  worked  out  as  specific  instances  are  ruled  upon. 
It  seems  that  even  under  the  strictest  construction  an 
amount  retained  for  employment  in  the  business  during 
the  following  year  is  reasonable,^  so  long  as  it  is  not  in 
excess  of  such  percentage  of  the  earnings  as  the  officers 
of  the  corporation  have  found  by  experience  in  previous 
years  to  be  necessary  to  take  care  of  the  normal  growth 
and  expansion  of  the  business.  Sums  which  may  be  re- 
tained for  the  p^^ose  -of  making  up  losses  in  "lean" 
years  will  probably  be  held  not  to  be  "  reasonable ' '  since 
the  advent  of  a  lean  year  is  a  contingency  which  cannot 
be  anticipated  with  any  reasonable  certainty.  Amounts 
retained  for  the  purpose  of  equalizing  dividends  in  the 
future  would  seem  to  be  retained  rather  as  a  matter  of 
advisability  or  expediency,  than  for  the  reasonable  re- 
(juirements  of  the  business.  Income  retained  by  a  cor- 
poration for  the  purpose  of  meeting  any  definite  obliga- 
tion coming  due  at  a  certain  time  in  the  future  is  retained 
for  the  reasonable  requirements  of  the  business. 
Amounts  set  aside  in  sinking  funds  to  pay  off  mortgages 
would  come  within  this  class,  unless  the  amount  set  aside 
in  any  year  is  clearly  much  greater  than  reasonably 
necessary,  considering  the  amount  of  the  mortgage 
debt,  the  amount  previously  set  aside  in  the  sinking 
fund,  and  the  length  of  time  to  elapse  before  the  due 
date  of  the  mortgage.  The  earnings  of  a  corporation 
used  to  purchase  preferred  stock  for  cancellation  are 
held  to  be  retained  for  employment  in  the  reasonable 
requirements  of  the  business  and  therefore  not  taxable.* 

6  T.  D.  2570. 


I 


tax  on  undistkibiitbd  income  op  corporations   501 

,  Net  Income  Invested  in  Obligations  op  the  United 
States.  In  order  to  avoid  any  question  as  to  whether 
or  not  the  undistributed  net  income  for  the  year  has  been 
retiiined  for  the  reasonable  requirements  of  the  business, 
such  income  may  be  invested  in  obligations  of  the  United 
States  issued  after  September  1,  1917.  Any  amount  so 
invested  may  be  deducted,  for  the  purpose  of  this  tax, 
whether  or  not  it  is  necessary,  or  merely  advisable,  to 
retain  such  amount  for  employment  in  the  business  at 
some  future  time.  Such  part  of  the  net  income  for  the 
current  year  as  may  be  invested  in  the  first  issue  of 
Liberty  Loan  bonds  will  be  subject  to  the  tax  unless,  by 
such  investment,  the  amount  is  employed  in  the  business 
or  the  amount  is  retained  for  employment  in  the  reason- 
able requirements  of  the  business.®  The  exemption  as  to 
investment  in  obligations  of  the  United  States  applies 
only  to  such  obligations  as  are  issued  after  September  1, 
1917. 

Rate  of  Tax.  On  the  amount  of  net  income  remaining 
undistributed  six  months  after  the  end  of  each  calendar 
or  fiscal  year,  after  deducting  the  several  deductions 
described  above,  a  tax  of  10%  is  levied.  The  law  does 
not  contain  any  provision  as  to  when  the  tax  is  due  and 
payable  or  to  whom  it  shall  be  paid.  Such  administrative 
details  are  left  to  be  covered  by  regulations^ 

«T.  D.  2570. 

7  As  first  proposed  this  provision  of  the  law  gave  only  a  period 
of  two  months  in  which  to  distribute  the  earnings  for  the  pre- 
ceding calendar  or  fiscal  year,  and  it  was  apparently  the  intention 
of  Congress  that  the  amount  remaining  undistributed  should  be 
reported  upon  the  form  of  return  of  annual  net  income,  and  that 
the  tax  should  be  paid  at  the  same  time  and  in  the  same  manner 
Ro  the  income  tax.     The  present  period  of  six  months  in  which  to 


502  APPENDIX 

Penalty  Tax.  If  a  corporation  has  reported  its  net 
income  for  a  calendar  or  fiscal  year  as  being  employed 
in  the  business,  and  the  Secretary  of  the  Treasury  ascer- 
tains and  finds  that  any  portion  of  such  amount  is 
not  so  employed,  or,  if  the  corporation  has  reported 
an  amount  to  be  retained  for  employment  in  the 
reasonable  requirements  of  the  business,  and  the  Sec- 
retary of  the  Treasury  ascertains  that  the  amount  is 
not  reasonably  required  in  the  business,  a  tax  at  the 
rate  of  15%,  instead  of  10%,  is  imposed  upon  such 
amount.  It  should  be  noted  that  this  provision  prac- 
tically makes  the  Secretary  of  the  Treasury  judge  as  to 
when  the  earnings  are  employed  in  the  business,  or  what 
the  reasonable  requirements  of  the  business  may  be.  The 
provision  is  intended  as  a  means  of  deterring  officers 
of  corporations  from  making  too  liberal  allowances  for 
the  reasonable  requirements  of  the  business.  In  effect, 
the  provision  imposes  a  penalty  of  50%  of  the  amount 
of  tlie  tax  for  understatement  of  the  taxable  undis- 
tributed earnings. 

Returns.  The  law  does  not  indicate  when  or  with 
whom  the  returns  on  which  this  tax  is  to  be  assessed 
should  be  filed.  The  matter  is  left  entirely  to  the 
Treasury  Department,  which  has  issued  no  regulations 
at  the  time  of  this  writing. 


make  distribution  of  the  earnings  eliminates  this  method  of  re- 
porting and  paying  the  tax. 


I 


I 


CHAPTER  45 

TUE  WAR  EXCESS  PROFITS  TAX 

This  momentous  tax  measure  ^  was  framed  by  a  Con- 
ference Committee  composed  of  members  of  the  House 
and  the  Senate,  in  the  last  days  of  the  First  Session  of 
the  65th  Congress,  under  stress  and  in  a  hurry.  It  bears 
many  evidences  of  hurried  workmanship,  and  lack  of 
careful  consideration  of  the  effect,  one  upon  the  other, 
of  the  many  uncorrelated  provisions.*  In  the  early 
days  of  the  session  the  House  of  Representatives  intro- 
duced a  measure  proposing  to  raise  the  rate  of  the  then- 
existing  excess  profits  tax.  This  was  succeeded  by  a 
proposal  of  the  Senate  Finance  Committee  to  make  the 
measure  a  war  profits  tax,  that  is,  a  tax  on  the  excess 
of  profits  for  the  current  year  over  the  average  profits 
for  the  pre-war  period.  The  final  result  wa.^  a  com- 
promise between  the  adherents  of  the  two  proposals, 

1  Act  of  October  3,  1917  (Public  No.  50),  65th  Ctongrress,  Title  IT, 
J  §200  to  214,  inclusive. 

8  This  chapter  is  written  before  any  indication  has  been  given 
liy  the  Treasury  Department  of  its  construction  of  the  law.  No 
attempt  is  made  to  foreshadow  the  rulings  which  will  be  issued. 
In  the  opinion  of  the  author,  the  law  is  so  defective  that  extensive 
amendment  will  be  necessary  before  it  can  be  applied  to  the  pur- 
pose for  which  it  was  drafted.  Many  indications  lead  to  the  con- 
clusion that  pressure  will  be  brought  to  bear  on  Congress  to  amend 
the  law  as  soon  as  possible,  and  perhaps  before  any  tax  is  assessed 
under  the  present  statute. 

503 


504  APPENDIX 

and  the  present  tax  is  neither  a  tax  on  excess  profits  nor 
a  tax  on  war  profits,  but  a  tax  partaking  of  the  character- 
istics of  both.  The  tax  is  imposed  on  income  over  a 
fixed  minimum  exemption  and  a  deduction  of  varying 
percentages  of  the  invested  capital.  The  taxability  of  a 
business  concern  existing  during  the  prewar  period  is 
affected,  but  only  slightly,  by  the  rate  of  its  earnings  on 
invested  capital  during  that  period.  The  taxpayers 
under  this  statute  are  divided  into  four  classes,  special 
provisions  applying  to  each  class.  These  classes  are  (a) 
domestic  corporations  and  partnei*ships,  (b)  individuals, 
citizens  of  or  residing  in  the  United  States,  (c)  foreign 
corporations  and  partnei'ships  and  (d)  non-resident  alien 
individuals.  The  tax  is  imposed  upon  the  entire  net 
income  of  every  corporation  and  partnership  and  upon 
the  net  income  of  every  individual  derived  from  busi- 
ness, trade,  profession  or  occupation.  The  individual 
investor,  it  seems,  who  is  not  engaged  in  any  business, 
trade,  profession  or  occupation,  is  not  intended  to  be 
taxed,  but  the  individual  deriving  an  income  from  a 
salary  is  within  the  purview  of  the  law.  For  the  purpose 
of  the  discussion  in  this  chapter,  a  general  statement  of 
how  the  tax  is  imposed,  or  what  might  be  called  a  for- 
mula, is  given  in  the  following  paragraph,  the  terms  and 
phrases  used  therein  being  defined  in  succeeding  para- 
graphs. 

General  Statement.  The  tax  is  imposed  on  the 
amount  of  net  income  ^  from  any  trade  or  business  *  for 
the  taxable  year^  after  deducting  (a)   an  amount  not 

S  See  Definition  on  pp.  509  to  512. 

4  See  Definition  on  p.  508. 

5  See  Definition  on  p.  507. 


THK    WAK    EXCESS   PROFITS   TAX  505 

less  than  7%  nor  more  than  9%  '  of  the  invested  capi- 
tal and  (b)  the  specific  exemption  allowed  by  the  law,' 
at  graduated  rates®  unless  no  invested  capital  or  not 
more  than  a  nominal  capital  *•  is  employed,  in  which 
case  the  tax  is  8%  of  the  net  income  of  such  trade  or 
business  in  excess  of  the  specific  exemption  allowed  by 
law.  The  tax  will  be  assessed  on  information  given  by 
the  taxpayer  in  his  or  its  return  of  annual  net  income, 
(partnerships  being  required  to  file  returns  for  this  pur- 
pose) and  will  be  due  and  payable  at  the  same  time  as 
the  income  tax. 

Corporation.  The  term  "corporation"  includes  joint 
stock  companies  or  associations,  and  insuranjce  com- 
panies.** A  domestic  corporation  is  one  created  under 
the  laws  of  the  United  States  or  of  any  state,  territory 
or  district  thereof.  A  foreign  corporation  is  one  created 
under  the  laws  of  Porto  Rico,  the  Philippines,  the  Pan- 
ama Canal  Zone,  Virgin  Islands  or  the  laws  of  any  other 
possession  of  the  United  States  or  the  laws  of  any  foreign 
country  or  Government.*'  Corporations  exempt  from 
the  income  tax  are  also  exempt  from  this  tax.**  A 
foreign  corporation  deriving  less  than  $3,000  of  net 
income  from  sources  within  the  United  States  during  a 
taxable  year  is  not  required  to  pay  any  tax.** 

«  See  p.  527. 

7  See  Definition  on  pp.  512  to  526. 

8  See  Definition  on  p.  529. 

9  See  Definition  on  p.  530. 

10  See  Definition  on  p.  526. 

11  The  term,  as  used  in  this  law,  has  the  same  meaning  as  in  the 
income  tax  law.  For  a  discussion  of  the  definition  under  that  law 
see  Chapter  12. 

18  Section  200. 

IS  Section  201,  see  Chapter  15. 

14  Section  202. 


506  APPENDIX 

Partnerships.  The  law  does  not  define  the  term 
"partnerships/'  but  the  intent  is,  undoubtedly,  to  in- 
clude all  kinds  of  partnerships,  general  and  limited. 
Limited  partnerships  have  been  held  by  the  Treasury 
Department  to  come  within  the  definition  of  the  term 
"corporations."^^  A  domestic  partnership  is  one 
created  under  the  law  of  the  United  States,  or  of  any 
state,  territory  or  district  thereof.  A  foreign  partner- 
ship is  one  created  under  the  law  of  any  other  possession 
of  the  United  States  or  of  any  foreign  country  or  gov- 
ernment.^® Partnerships  carrying  on  or  doing  the  same 
business,  or  coming  within  the  same  description,  as  cor- 
porations exempt  from  the  income  tax  law,  are  exempt 
from  this  tax.^''  A  foreign  partnership  deriving  less 
than  $3,000  of  net  income  from  sources  within  the  United 
States  during  a  taxable  year  is  not  required  to  file  a 
return  or  pay  any  tax.^* 

Individuals.  Special  provisions  apply  to  individuals 
who  are  citizens  and  residents  of  this  country.  The 
definition  of  the  term  "citizens  and  residents"  will  un- 
doubtedly be  the  same  as  that  made  with  respect  to  the 
income  tax  law,^'  except  that  the  term  * '  United  States ' ' 
as  defined  in  this  statute  does  not  include  Porto  Rico, 
the  Philippines  or  other  possessions.  It  would  seem 
that  Congress  did  not  intend  the  tax  to  apply  to  the 
incomes  of  the  citizens  and  residents  of  those  possessions, 
except  to  the  extent  that  such  income  is  derived  from 
business  or  trade  conducted  within  the  ' '  United  States, ' ' 

16  See  Cihapter  12. 

16  See  Section  200. 

17  Section  201;  see  Chapter  15. 

18  Section  202. 

19  See  Chapter  4. 


THE   WAR  EXCESS  PROFITS  TAX  507 

as  the  term  is  defined  in  the  foUowiHg  paragraph.  The 
term  "non-resident  alien  individuals"  is  not  defined  in 
the  statute  but  the  definition  of  the  Treasury  Depart- 
ment, under  the  income  tax  law,  will  probably  be  applied 
to  the  term  as  used  in  this  statute.*®  Individuals  carry- 
ing on  or  doing  the  same  business,  or  coming  within 
the  same  description,  as  corporations  exempt  from  the 
income  tax,  are  exempt  from  this  tax.  Officers  and  em- 
ployees of  the  United  States,  or  any  state,  territory  or 
the  District  of  Columbia,  or  any  local  subdivision  thereof, 
are  exempt  with  respect  to  the  compensation  or  fees  re- 
ceived by  them  as  such  officers  or  employees.*^  A  non- 
resident alien  deriving  less  than  $3,000  of  net  income 
from  sources  within  the  United  States  during  a  taxable 
year  is  not  required  to  pay  any  tax  under  this  law.** 

United  States.  The  term  "United  States"  means 
only  the  states,  the  territories  of  Alaska  and  Hawaii, 
and  the  District  of  Columbia.*'  In  view  of  this  definition 
a  foreign  corporation,  or  partnership,  or  a  non-resident 
alien,  deriving  income  from  Porto  Rico,  Philippines, 
Virgin  Islands,  Panama  Canal  Zone  and  other  posses- 
sions will  not  be  subject  to  this  tax. 

Taxable  Year.  In  the  case  of  individuals,  the  term 
"taxable  year"  means  the  calendar  year,  the  first  taxable 
year  being  the  year  1917.  In  the  case  of  corporations 
and  partnerships,  the  term  means  the  calendar  year, 
unless  the  corporation  or  partnership  has  fixed  its  own 
fiscal  year,   in  which  case  it  means  such  fiscal  year. 

80  See  Chapter  5. 

21  Section  201. 

22  Section  202 
28  Section  200. 


508  APPENDIX 

Where  a  fiscal  year  has  been  fixed,  the  first  taxable  year 
is  the  fiscal  year  ending  in  1917,  In  such  cases,  the  tax 
for  such  fiscal  year  will  be  that  proportion  of  the  tax 
computed  upon  the  net  income  for  the  full  fiscal  year 
which  the  time  in  1917  bears  to  the  full  fiscal  year.^* 
The  tax  will  be  computed  upon  the  full  income  for  the 
fiscal  year,  but  only  such  part  thereof  will  be  assessed 
as  is  ascertained  by  multiplying  the  amount  computed 
for  the  full  fiscal  year  by  the  fraction  of  the  fiscal  year 
falling  in  the  calendar  year  1917.  For  example,  if  one- 
third  of  the  fiscal  year  falls  in  the  calendar  year  1917, 
one-third  of  the  full  amount  of  the  tax  so  computed  will 
be  assessed. 

Prewar •  Period.  The  term  "prewar  period"  means 
the  calendar  years  1911,  1912  and  1913.  If  a  corpora- 
tion or  partnership  was  not  in  existence  during  the  whole 
of  such  period,  its  "prewar  period"  will  be  as  many  of 
such  years  during  the  whole  of  which  it  was  in  existence. 
If  an  individual  was  not  engaged  in  trade  or  business 
during  the  whole  of  such  period,  his  "prewar  period" 
will  be  as  many  of  such  years  during  the  whole  of  which 
he  was  engaged  in  the  trade  or  business.^^  The  purpose 
of  fixing  a  prewar  period  is  solely  to  determine  what 
particular  percentage  of  invested  capital  between  7% 
and  9%  may  be  taken  by  the  taxpayer  as  a  deduction.*^ 

Trade  and  Business.  The  term  "trade  and  business" 
is  defined  in  the  law  to  include  professions  and  occupa- 
tions.*^ The  term  has  no  particular  value  with  reference 
to  corporations  and  partnerships,  since  every  corporation 

24  Section  200. 

26  Section  200. 

26  Section  203. 

27  Section  200. 


THE    WAR   KXCESS   PROFITS   T.VX  509 

aud  partnership  is  deemed  to  be  engaged  in  business 
and  all  of  its  income  is  deemed  to  be  the  income  of  a 
single  trade  or  business.*'  In  other  words,  the  tax  is 
not  imposed  with  respect  to  income  from  the  trade  or 
business  of  a  corporation  or  partnership,  but  with  re- 
spect to  its  entire  net  income  from  all  taxable  sources. 
With  respect  to  individuals,  the  Treasury  Department 
lias  already  defined  the  term  "trade  or  business"  under 
the  income  tax  law.*^  The  term  has  been  given  a  very 
narrow  construction  under  the  income  tax  law,  and  it 
has  been  held  that  one  deriving  income  from  the  pur- 
chase and  sale  of  securities  is  not  engaged  in  business, 
unless  he  is  a  member  of  an  -exchange.  This  ruling 
was  made  with  reference  to  deducting  losses  incurred  in 
trade,  and  it  was  naturally  to  the  interest  of  the  Gov- 
♦'rnmeut  to  give  a  verj'  narrow  definition  to  the  term 
in  trade."  It  is  not  at  all  unlikely  that  under  the 
present  law  the  same  term  will  be  given  a  broader  defini- 
tion, since  the  interests  of  the  Government  are  now 
served  by  including  as  many  activities  as  possible  within 
the  terra,  and  the  present  statute  expressly  defines  the 
terra  to  include  "all  trades  or  businesses  of  whatever 
description,  whether  continuously  carried  on  or  not," 
including  "professions  and  occupations."*®  Income 
derived  from  the  business  of  life,  liealth,  aud  accident 
insurance  combined  in  one  policy  Issued  on  the  weekly 
premium  payment  plan  is  exempt  from  the  tax.'* 

Net  Income  of  Domestic  Corporations.    The  net  in- 
line of  a  domesrtic  corporation,  to  which  this  tax  applies, 


I 

i 


88  Section  201. 

89  See  Chapter  4,  p.  32. 

30  Section  200  and  section  201, 
«  Section  201. 


510  APPENDIX 

is  the  income  of  the  taxable  year  as  reported  in  the  re- 
turn of  net  income,  except  that  the  amounts  received 
by  it  as  dividends  upon  the  stock  or  from  the  net  earn- 
ings of  other  corporations  subject  to  the  income  tax 
are  deducted.'*  It  is  to  be  noted  that  the  net  income  is 
ascertained  by  excluding  income  defined  to  be  exempt 
under  the  income  tax  law,  and  further,  by  excluding 
dividends  received  from  corporations  subject  to  the  in- 
come tax.  It  is  also  to  be  noted  that  such  dividends 
may  be  deducted  if  the  corporation  is  subject  to  the 
income  tax,  although  it  may  not  be  subject  to  this  excess 
profits  tax.  Dividends  received  from  corporations,  not 
subject  to  the  income  tax,  may  not  be  deducted. 

Net  Income  for  Prewar  Period.  The  net  income  of  a 
domestic  corporation  for  the  year  1911  is  to  be  deter- 
mined according  to  the  provisions  of  the  1909  Law  (ex- 
cluding dividends)  except  that  the  amount  of  the  tax 
assessed  by  the  Federal  Government  on  the  income  of 
the  corporation  for  the  year  1910  (and  paid  by  the  cor- 
poration in  1911)  should  not  be  deducted.®'  Corpora- 
tions were  permitted  to  deduct  such  amounts  in  ascer- 
taining their  net  income  under  the  1909  Law,  but  in 
ascertaining  the  net  income  of  the  prewar  period,  for 
the  purpose  of  this  tax,  the  amount  need  not  be  deducted. 
It  is,  of  course,  a  slight  advantage  to  the  corporation 
to  include  the  amount  of  such  taxes,  in  order  to  increase 
the  amount  of  income  for  the  prewar  period.     The  net 

32  Section  206. 

33  The  language  of  the  statute  is  ' '  except  that  income  taxes  paid 
by  it  within  the  year  imposed  by  the  authority  of  the  United  States 
shall  be  included. ' '  The  tax  imposed  by  the  1909  Law  was  not*an 
income  tax  but  an  excise  tax  but  Congress  undoubtedly  had  refer- 
ence to  that  tax  in  using  the  language  quoted. 


THE  WAR  EXCESS  PROFITS   TAX  511 

income  for  1912  is  ascertained  in  tlie  same  manner  ws 
indicated  above  for  1911,  except  that  the  tax  imposed  by 
the  Federal  Government  upon  the  net  income  of  the  cor- 
poration for  the  year  1911  (and  paid  by  the  corporation 
in  1912)  should  be  included.  The  net  income  for  the 
year  1913  is  ascertained  in  the  manner  provided  by  the 
1913  Law,  except  that  the  tax  assessed  under  the  1909 
Law  on  income  for  1912  (and  paid  in  1913)  should  be 
included,  and  the  amount  received  by  the  corporation  as 
dividends  upon  the  stock  of  other  corporations  taxable 
under  the  1913  Law  should  be  deducted,  ** 

Net  Income  of  Foreign  Corporations.  The  net  income 
of  a  foreign  corporation  is  the  net  income  received  from 
sources  within  the  I'nited  States,"  as  reported  for  the 
purpose  of  the  income  tax,  but  not  including  the  income 
received  from  dividends  of  domestic  or  resident  corpora- 
tions subject  to  the  income  tax.  It  follows  from  this  that 
in  so  far  as  a  foreign  corporation  receives  dividends 
from  this  country  it  is  not  subject  to  the  tax  imposed  by 
tiiis  law. 

Net  Income  for  Prewar  Period.  The  income  of  a 
foreign  corporation  for  the  prewar  period  is  ascertained 
in  the  same  manner  as  indicated  above  in  the  case  of 
domestic  corporations,  except  that  it  will  include  only 
net  income  received  during  that  "period  from  sources 
within  the  United  States.  *• 

Net  Income  of  Partnerships.  The  net  income  of  do- 
mestic partnerships  is  determined  in  the  same  manner 

34  Section  206. 

35  Section  200  and  section  206.  See  Definition  of  United  States, 
supra. 

Mid. 


512  APPENDIX 

as  in  the  case  of  citizens  and  residents  of  this  country, 
and  the  net  income  of  foreign  partnerships  is  determined 
in  the  same  manner  as  in  the  case  of  non-resident  aliens. 

Net  Income  of  Individuals.  The  net  income  of  in- 
dividuals (and  of  partnerships)  is  ascertained  for  the 
years  of  the  prewar  period,  and  for  the  taxable  year, 
upon  the  same  basis  and  in  the  same  manner  as  provided 
in  the  1916  Law,  as  amended,  except  that  dividends  re- 
ceived from  a  corporation  taxable  upon  its  net  income 
may  be  deducted.  It  is  to  be  noted  that  returns  of  net 
income  filed  for  the  year  1913  do  not  disclose  the  net 
income  required  to  be  reported  under  this  law,  since  the 
1913  Law  differed  in  many  respects  from  the  1916  Law. 
The  net  income  of  citizens  and  residents  and  the  net  in- 
come of  non-resident  aliens  will  be  ascertained,  respec- 
tively, by  following  the  provisions  applicable  to  each 
class.  The  law  is  not  clear  as  to  whether  or  not  an  indi- 
vidual engaged  in  two  or  more  businesses  should  report 
separately  the  income  from  each  business,  or  even  if,  by 
reason  of  being  engaged  in  business,  he  must  report  all 
his  income  from  every  source,  except  dividends.^'' 

Invested  Capital.  Invested  capital  as  used  in  the  law, 
is  what  the  law  defines  it  to  be,  and  not  what  is  generally 
understood  by  the  term.  It  does  not  mean  the  assets  of 
a  business  or  trade  or  the  book  value  of  a  plant.  Gener- 
ally speaking,  it  means  the  amount  which  has  been  con- 
tributed by  the  stockholders  of  a  corporation,  the  mem- 
bers of  a  partnership,  or  the  individual  engaged  in  busi- 
ness on  his  own  account,  to  the  business,  either  directly, 
or  by  permitting  the  earnings  of  the  corporation,  part- 
nership or  business  to  be  kept  in  the  business.    Money  or 

87  See  §  206,  second  paragraph,  §  201,  first  paragraph. 


THE   WAR   KXCESS  PROFITS  TAX  513 

property  borrowed  is  not  * '  invested  capital. ' '  P^urther, 
capital  which  may  have  been  contributed  to  the  business 
loses  the  status  of  "invested  capital"  by  being  invested 
in  stocks  (the  dividends  of  which  are  not  included  in 
net  income)  or  by  being  invested  in  state,  municipal  or 
other  bonds  of  that  character  (the  interest  on  which  is 
exempt  under  the  income  tax  law)  or  other  assets,  the 
income  from  which  is  not  subject  to  the  tax.  An  excep- 
tion is  made  in  the  case  of  capital  invested  in  the  obli- 
gations of  the  United  States.  Such  capital  does  not  lose 
its  status  as  "invested  capital"  although  the  interest 
from  the  bonds  may  be  excluded  from  net  income.^'  The 
intent  of  the  law  seems  to  be  that  if  capital  is  invested  in 
an  asset  the  income  from  which,  if  any,  would  not  be  in- 
cluded as  net  income,  the  capital  so  invested  shall  not 
be  included  as  "invested  capital"  for  the  purpose  of 
ascertaining  the  amount  of  deduction.  Thus,  if  capital 
is  invested  in  stocks,  bonds  or  other  assets  the  income 
from  which  would  not  be  taxable,  the  capital  invested  in 
such  assets  must  be  excluded,  whether  or  not  any  income 
is  actually  derived  from  the  assets  in  question.  ^^  The 
purpose  of  ascertaining  the  "invested  capital"  of  a  busi- 
ness is  to  allow  what  Congress  considered  a  fair  return 
or  earning  thereon  before  imposing  the  tax,  hence,  it 
follows  that  if  the  earnings  are  not  taxable  the  asset  is 
not  "invested  capital." 

Average  Invested  Capital  tor  the  Year.  Since,  as 
indicated  in  the  preceding  paragraph,  the  amount  of  in- 

38  The  purpose  of  this  exception  is,  of  course,  to  stimulate  in- 
vestment in  bonds  and  certificates  of  indebtedness  issued  by  the 
United  States  for  the  purpose  of  raising  money  to  defray  the  cost 
of  the  war. 

»»  Section  207. 
F.  I.  Tast.— 3.3 


514  APPENDIX 

vested  capital  niay  vary  from  time  to  time,  depending 
upon  the  kind  or  character  of  asset  in  which  the.  capital 
of  the  business  may  be  invested,  and  for  other  reasons, 
as  will  appear  more  fully  in  the  following  paragraphs, 
the  law  provides  that  the  invested  capital  shall  not  be  de- 
termined as  of  any  particular  day  in  the  year,  but  shall 
be  "averaged  monthly."  The  intent  of  this  provision 
would  seem  to  be  that  the  amount  of  invested  capital 
shall  be  ascertained  on  some  j^articular  day  of  each 
month,  in  order  to  obtain  the  average  for  the  year. 

Business  Carried  on  by  Successor.  If  a  trade  or 
business  carried  on  by  a  corporation,  partnership,  or  in- 
dividual, lias  been  organized  or  reorganized  on  or  after 
January  2,  1913,  the  new  business  concern  being  sub- 
stantially a  continuation  of  the  trade  or  business  carried 
on  prior  to  that  date,  the  successor  is  deemed  to  have  been 
in  existence  prior  to  that  date,  and  the  net  income  and 
invested  capital  of  its  predecessor  prior  to  that  date  is 
deemed  to  have  been  its  net  income  and  invested  capital 
for  the  prewar  period  prior  to  that  date.***  If  a  reorgani- 
zation, consolidation,  or  change  of  ownership  of  a  trade 
or  business  takes  place  after  IMarch  3,  1917,  no  assets 
transferred  or  received  from  the  prior  trade  or  business 
shall  be  allowed  a  greater  value  than  would  have  been 
allowed  in  computing  the  invested  capital  of  the  prede- 
cessor (a)  if  an  interest  or  control  in  such  trade  or 
business  of  50%  or  more  remains  in  control  of  the  same 
persons,  corporations,  associations,  partnerships,  or  any 
of  them,  (b)  unless  such  asset  was  paid  for  specifically 
as  such,  in  cash  or  tangible  property,  and  then  not  to 
exceed  the  actual  cash  or  actual  cash  value  of  the  tang- 


40  Section  204. 


k 


THE  WAR  EXCESS   PROFITS  TAX  515 

il)lo  property  paid  tlierefor  at  the  time  of  such  pay- 
ment.*^ 

Invested  Capital  of  Corporations  and  Partnerships. 

Sul)j«H't  to  the  limitations  discussed  in  the  three  preced- 
ing paragrapljs,  the  law  provides  a  particular  method  for 
determining  the  invested  capital  of  a  corporation  or 
partnership,  which  will  he  discussed  in  the  following 
paragraphs.  Briefly,  the  invested  capital  in  such  cases, 
consists  of  (a)  the  actual  cash  paid  in,  (h)  the  actual 
cash  value  of  tangible  property  paid  in,  (c)  subject  to 
certain  limitations,  the  actual  cash  value  of  patents  and 
copyrights  paid  in  for  stock  or  shares,  (d)  subject  to  cer- 
tain limitations,  the  actual  cash  value  of  good-will,  trade- 
marks, trade-brands,  the  franchise  of  a  corporation  or 
partnership  or  other  intangible  property  paid  in  for 
stock  or  shares  issued  prior  to  March  3,  1917,  and  (e) 
paid  in  or  earned  surplus  and  undivided  profits  used 
and  employed  in  the  business.** 

A(;tual  Cash  Paid  in.  This  means  the  actual  amount 
of  money  paid  in  by  shareholders  or  members  for  stock 
or  shares.  It  should  be  noted  that  the  actual  cash 
paid  in  is  to  be  taken,  not  the  par  value  of  the  stock 
which  may  have  been  issued  therefor.  Tf  more  than  par 
was  paid  for  stock  the  entire  amount  so  paid  may  be 
treated  as  actual  cash  paid  in,  or  an  amount  equal  to 
the  par  value  of  the  stock  may  ])e  treated  as  actual  cash 
paid  in  and  tlie  e.xce.ss  as  ''paid  in  surplus,"  but  the 
same  amount  should  not  be  included  under  Ijoth  heads, 
ft  swms  that  under  this  head  .should  be  included  not 
"lily  cash  liut  the  "crjuivalent  of  ca.sh,"  that  i.s,  if  stock 

*1  Section  208. 
«  Section  207a. 


516  APPENDIX 

of  the  l;axable  corporation  has  been  issued  for  securities 
which  had  an  ascertainable  value  at  the  time,  such 
securities  should  be  treated  as  the  "equivalent  of  cash" 
and  the  value  at  the  time  of  issue  taken  to  be  actual 
cash  paid  in.*^ 

Tangible  Property  Paid  in.  Where  tangible  prop- 
erty (other  than  cash)  has  been  paid  in  by  stockholders 
or  members,  for  stock  or  shares,  the  actual  cash  value  of 
such  tangible  property,  at  the  time  of  such  payment,  may 
be  included  as  "invested  capital"  (but  in  case  such 
tangible  property  was  paid  in  prior  to  January  1,  1914, 
the  actual  cash  value  of  such  property  as  of  January  1, 
1914,  but  in  no  case  to  exceed  the  par  value  of  the  orig- 
inal stock  or  shares  specifically  issued  therefor).  The 
phrase  ' '  tangible  property ' '  as  used  in  this  section  must 
be  given  a  liberal  construction  in  order  not  to  work 
undue  hardship  on  taxpayers.  It  will  include,  of  course, 
all  property  which  is  "tangible"  and  should  in  addition 
include  mining  rights,  oil  leases,  and  similar  species  of 
property,  in  cases  wliere  the  consideration  for  such 
property  was  paid  in  a  specific  sum  by  the  one  contrib- 
uting it  to  the  corporation  or  partnership,  and  is  not 
merely  in  the  form  of  annual  rentals  or  royalties.  The 
value  of  tangible  property  must  be  taken  as  of  the  time 
it  was  paid  in  to  the  corporation  or  partnership  in  ex- 
change for  stock  or  shares,  except  in  cases  where  it  was 
so  paid  in  prior  to  January  1,  1914,  in  which  case  the 
\alue  on  January  1,  1914  shall  be  taken.  In  this  connec- 
tion, the  law  provides  that  the  value  as  of  January  1, 
1914,  shall  in  no  case  exceed  the  par  value  of  the  original 

*3  This  seems  to  be  necessary  if  any  credit  is  to  lie  ^ven  for 
property  so  aecjuired. 


I 


THE  WAR  EXCESS  PROFITS  TAX  517 

stock  or  shares  specifically  issued  for  the  property.  It 
is  not  conceivable  that  Congress  intended  what  the  law 
literally  says,  as,  for  instance,  there  are  many  cases  in 
which  corporations  have  issued  merely  nominal  amounts 
of  stock  in  exchange  for  property  of  great  value,  and  to 
hold  that  the  "invested  capital"  in  such  cases  cannot 
exceed  the  par  value  of  the  stock  would  be  so  unreason- 
able and  unjust  as  to  raise  doubts  of  the  constitutionality 
of  the  law.  Where  property  of  greater  value  than  the 
stock  issued  therefor  has  been  transferred  to  a  corpora- 
tion prior  to  January  1,  1914,  an  amount  equal  to  the 
par  value  of  the  stock  should  be  treated  as  capital,  and 
the  excess  as  "paid  in  surplus." 

Patents  and  Copyrights.  Patents  and  copyrights 
are  a  species  of  intangible  property  which  may  be  con- 
sidered, when  issued  for  stock  or  shares,  in  ascertaining 
"invested  capital."  The  actual  cash  value  of  such  pat- 
ents and  copyrights,  at  the  time  they  were  paid  in  for 
the  stock  or  shares,  may  be  included  as  "invested  capi- 
tal," but  not  to  exceed  the  par  value  of  the  stock  or 
shares  issued  therefor.  It  seems  that  the  actual  cash 
value  at  the  time  patents  and  copyrights  are  paid  in 
determines  the  amount  of  invested  capital,  regardless  of 
whether  or  not  the  time  is  before  or  after  the  enactment 
of  the  law. 

Good-will.  Good-will  may  be  considered  subject  to 
the  limitations,  and  under  the  conditions,  discussed  in  a 
following  paragraph  entitled  "Intangible  Property." 

Trade-marks.  Trade-marks  may  be  considered  sub- 
ject to  the  limitations,  and  under  the  conditions,  dis- 
cussed in  a  following  paragraph  entitled  "Intangible 
Property." 


518  ■  APPENDIX 

Tkaue-bbands.  Trade-brands  may  be  considered  sub- 
jet;!  to  the  limitations,  and  under  the  conditions,  dis- 
cussed in  a  following  paragraph  entitled  "Intangible 
Property." 

Franchise  op  a  Corporation  or  Partnership,  The 
franchise  of  a  corporation  or  partnership  may  be  con- 
sidered subject  to  the  limitations,  and  under  the  condi- 
tions, discussed  in  the  following  paragraph  entitled 
' '  Intangible  Property. ' ' 

Intangible  Property.     The  law  provides  that  good- 
will, trade-marks,  trade-brands,  the  franchise  of  a  cor- 
poration or  partnership,  or  other  intangible  property, 
may  be  included  as  invested  capital  if  the  corporation 
or  partnership  made  payment  in  good  faith  therefor, 
specifically  as  such,  in  cash  or  tangible  property.     This 
is  one  of  the  many  obscure  provisions  of  the  law  and  it  is 
difficult  to  understand  the  reason  for  inserting  the  lan- 
guage, since,  if  payment  is  made  for  such  intangible 
])roperty  with  cash  or  tangible  property,  it  must  either 
be  cash  or  tangible  property  contributed  by  the  stock- 
holders or  members,  or  cash  or  tangible  property  bor- 
rowed.   In  the  former  case  the  consideration  has  already 
been  included  as  invested  capital  and  in  the  latter  case 
the   law   expressly   provides  that   borrowed    money   or 
property  cannot  be  so  included.     The  law  further  per- 
mits such  intangible  property  to  be  considered  in  ascer- 
taining invested  capital,  when  paid  for  in  stock  or  shares 
of  the  corporation  or  partnership,  under  the  following 
conditions  and  limitations:     (a)  the  intangible  property 
must  have  been  purchased  in  good  faith  prior  to  March 
3,  1917,  and  the  stock  or  shares  in  payment  thereof  must 
have  been  issued  prior  to  March  3,  1917,  (b)  the  amount 


L 


THE   WAR   EXCESS   PROFITS  TAX  5l9 

of  shares  which  may  be  considered  as  having  been  issued 
for  such  intangible  property  is  an  amount  not  to  exceed 
(on  March  3,  1917)  20%  of  the  total  interests  or  shares 
of  the  partnei-ship  or  corporation,  (c)  the  amount  which 
may  be  included  as  invested  capital  i^  the  actual  cash 
value  of  such  intangible  property  at  tlie  time  of  such 
purchase  limited,  however,  in  case  of  issue  of  stoci<  tliere- 
for  to  an  amount  not  to  exceed  the  par  value  of  sruch 
stock.  It  will  be  noted  from  (a)  above  that  good-will, 
trade-marks,  trade-brands,  franchise  of  a  corporation  or 
partnership,  or  other  intangible  property  paid  in  for 
stock  or  shares  may  not  be  considered  in  determining 
invested  capital  if  such  property  was  paid  in  on  or  after 
March  3,  1917.  The  permission  applies  only  to  trans- 
actions which,  took  place  prior  to  that' date.  It  should 
also  be  noted  that  if  the  property  was  paid  in  prior  to 
tiiat  date,  but  stock  or  shares  were  not  issued  until  on  or 
after  that  date,  the  transaction  eainiot  l)e  considered,  if 
the  law  is  to  be  literally  construed.  The  provision  stated 
in  (b)  above,  apparently  means  that  if  a  corporation 
or  partnership  issued  more  than  one-fifth  of  its  stock 
or  shares  for  such  intangible  property,  the  invested 
capital  may  be  computed  only  on  such  proportion  as 
is  represented  by  one-fifth  of  the  stock  or  shares.  If. 
for  instance,  a  corporation  had,  on  March  3,  1917.  two- 
fifths  of  its  stoi'k  issued  for  sruch  intangible  property, 
only  one-half  of  the  actual  cash  value  (at  the  time  it  was 
paid  in)  of  such  intangible  property  can  be  considered 
as  "invested  capital."  The  statement  under  (c)  above, 
indicates  that  in  this  case,  as  in  all  others,  the  value  of 
the  property,  for  which  shares  or  stock  have  been  issued, 
must  be  taken  as  of  the  time  the  property  was  acfjuired, 
and  the  stock  issued  therefor,  and,  further,  that,  in  the 
case  of  corporations  such  value  cannot  exceed  the  par 


520  APPENDIX 

value  of  the  stock  issued  therefor.  The  law  makes  no 
provision  for  cases  where  the  contributor  may  have  paid 
large  sums  of  money  for  intangible  property,  such  as 
rights,  franchises  and  good-will.  As  an  illustration,  an 
individual  may  have  purchased  a  trade-mark,  paying 
therefor  the  sum  of  $100,000.  If  -he  thereafter  forms  a 
corporation  and  transfers  the  trade-mark  to  it,  in  ex- 
change for  $100,000  of  stock,  the  corporation  may  not, 
under  the  language  of  the  law,  claim  any  amount  as 
invested  capital  with  respect  thereto.  On  the  other  hand, 
if  the  same  individual  had,  prior  to  March  3,  1917,  trans- 
ferred the  same  trade-mark  or  trade-brand  to  a  small 
corporation,  merely  as  a  matter  of  convenience,  in  ex- 
change for  the  issue  to  him  of  $1,000  of  capital  stock,  the 
corporation  would  not  be  permitted  to  claim  more  than 
$1,000  as  invested  capital.  If  the  individual  uses  the 
trade-mark  in  his  business,  without  incorporating  the 
business,  or  taking  in  a  partner,  he  may  claim  $100,000 
as  invested  capital.  Examples  of  this  sort  can  be  multi- 
plied indefinitely  to  show  the  imperfections  of  the  statute. 

Surplus  and  Undivided  Profits.  In  addition  to  the 
cash  and  property  paid  in  by  the  stockholders  or  mem- 
bers, a  corporation  or  partnership  may  include  the 
amount  of  "paid  in  or  earned  surplus  and  undivided 
profits  used  or  employed  in  the"  business,  exclusive  of 
undivided  profits  earned  during  the  taxable  year."** 
Surplus  and  undivided  profits  may  be  included  as  "in- 
vested capital,"  if  paid  in  by  the  stockholders  or  mem- 
bers, that  is,  contributed  in  cash  or  tangible  property, 
for  which  no  stock  or  shares  have  been  issued.  It  seems, 
for  instance,  that  if  tangible  property  has  been  "paid 
in"  to  a  corporation,  having  an  actual  cash  value  at  the 

44  Section  207a. 


THE   WAR  EXCESS  PBOriTS  TAX  521 

time  of  such  payment  greatly  in  excess  of  the  stock 
issued  for  it,  an  amount  equal  to  the  par  value  of  the 
stock  will  be  considered  as  capital  paid  in,  and  the  excess 
as  surplus  paid  in.  Earned  surplus  is  that  part  of  the 
surplus  which  has  been  accumulated  by  retaining  in  the 
business  a  part  of  the  earnings  of  any  year.  The  amount 
of  such  surplus  is  a  question  of  fact  to  be  determined  in 
each  particular  case.  The  amount  of  earned  surplus  of 
any  year  since  January  1,  1909,  will  probably  be  held  to 
be  the  amount  of  net  income,  shown  by  the  return  of  net 
income  of  the  corporation,  which  has  not  been  distributed 
in  the  form  of  dividends  to  the  stockholders.  If  in  any 
of  those  years  amounts  have  been  charged  to  expense, 
which  should  have  been  charged  to  capital,  the  corpora- 
tion may  perhaps  be  permitted  to  reopen  its  books,  ma!ie 
the  proper  entries  and  file  amended  returns.  With  re- 
spect to  the  years  prior  to  January  1,  1909,  it  seems  that 
amounts  which  should  actually  have  been  charged  to 
capital  may  be  considered  as  earned '  surplus  employed 
in  the  business,  provided  proof  of  that  fact  can  be 
produced. 

Used  or  Employed  in  the  Business.  Surplus  and 
undivided  profits  must  be  used  or  employed  in  the 
business  in  order  to  be  considered  as  invested  capital. 
Since  the  law  expressly  provides  that  a  corporation  or 
partnership  shall  be  deemed  to  be  engaged  in  business, 
and  all  trades  and  businesses  in  which  it  is  engaged  shall 
be  treated  as  a  single  business,  and  all  its  income  from 
whatever  sources  derived  shall  be  deemed  to  be  received 
from  such  trade  or  business,**  it  would  seem  to  follow 
that  if  surplus  and  undivided  profits  are  invested  in  any 
way  to  produce  "net  income"  within  the  meaning  of  this 
law,  such  surplus  and  undivided  profits  are  used  and 

«  Section  201. 


522  APPENDIX 

eiuplovred  in  the  business.  For  example,  if  the  surplus 
and  undivided  profits  are  invested  in  obligations  of  the 
United  States,  or  bonds  (other  than  state,  municipal  or 
other  bonds,  the  interest  of  which  is  not  included  in  ' '  net 
income")  it  should  be  considered  as  employed  in  the 
business.  The  criterion  seems  to  be  that  if  income  from 
the  asset  in  which  the  surplus  or  undivided  profits  are 
invested  would  be  included  in  the  return  for  the  purpose 
of  this  tax,  the  surplus  and  undivided  profits  are  "used 
and  employed  in  the  business,"  whether  or  not  any  in- 
come is  actually  derived  from  the  asset.  The  difficulty 
which  arises  is  to  earmark  the  capital,  surplus,  undivided 
profits  and  borrowed  money  of  a  corporation  in  order  to 
determine  whether  or  not  it  is  the  surplus  or  borrowed 
money  which  might  be  employed  in  assets  that  cannot  be 
included  as  "invested  capital."  For  instance,  a  corpora- 
tion may  have  a  capital  stock  of  $100,000,  surplus  and 
undivided  profits  of  $100,000  and  a  bond  issue  of 
$100,000.  Its  assets  may  consist  of  property  and  plant 
which  cost  it  $100,000,  taxable  bonds  which  cost  it 
$100,000  and  stock  which  cost  it  $100,000.  It  cannot  be 
said  that  either  the  capital,  surplus  or  borrowed  money 
is  invested  in  any  one  of  these  forms  of  assets.  The 
courts  have  held  that  capital  or  surplus  cannot  be  ear- 
marked, and  each  form  of  asset  contains,  in  equal  pro- 
portions, the  capital,  surplus  and  borrowed  money  of  the 
corporation.  Therefore,  it  would  seem  that  only  two- 
thirds  of  the  surplus  is  used  or  employed  in  the  business 
of  the  corporation  and  one-third  of  the  capital  is  invested 
in  the  stock.  Hence,  only  two-thirds,  or  $133,333,  of  the 
capital  and  surplus  is  ' '  invested  capital. ' '  If,  on  the  other 
hand,  the  borrowed  money  was  used  originally  for  the 
purchase  of  the  stock,  and  it  is  held  by  the  Treasury- 
Department  that  the  fund  can  be  earmarked,  the  cor- 


iJ 


THE  WAR  EXCESS   PROFITS  TAX  523 

poratiou  will  be  entitled  to  a  deduetiou  on  $200,000, 
since  then  its  capital  and  srurplus  will  be  invested  in 
plant  and  taxable  bonds.  The  law  gives  no  indication 
of  the  manner  in  which  to  meet  such  practical  difficul- 
ties as  this,  and  the  matter  is  one  largely  within  the 
discretion  of  the  Treasury  Department. 

Undivided  Profits  Earned  During  the  Taxable 
Year.  The  law  expressly  provides  that  surplus  and  un- 
divided profits  shall  not  include  "undivided  profits 
earned,  during  the  taxable  year,"  but  it  seems  that  sur- 
plus earned  during  the  taxable  year  may  be  so  included, 
that  is,  if  a  part  of  the  earnings  for  the  year  is  definitely 
set  aside  as  surplus,  and  not  merely  acieumulated  for  the 
purpose  of  distribution  at  the  end  of  the  year,  such 
amount  should  be  included  as  "invested  capital,"  pro- 
vided it  is  used  or  employed  in  the  business. 

Invested  Capital  of  Foreign  Corporations  and  Part- 
nerships. The  law  provides  that  in  the  ease  of  a  foreign 
corporation  or  partnership  its  "entire  invested  capital" 
shall  be  ascertained  in  the  manner  indicated  in  the  pre- 
ceding paragraphs.  That  proportion  of  the  entire  in- 
vested capital  which  the  net  income  from  sources  within 
the  United  States  bears  to  the  entire  net  income  of  the 
foreign  corporation  or  partnership  may  be  taken  as  the 
"invested  capital"  on  which  to  base  the  deduction  under 
tliis  law.*® 

Invested  Capital  in  the  Case  of  Individuals.  Subject 
to  the  limitations  disiuissed  in  the  panigraph  on  "in- 
\'>\M  capital"  and  the  two  paragraphs  following  it*''' 
ilio  law  provides  a  particular  method  for  determining  the 

*6  Section  207,  last  paragraph. 
«  See  pp.  512-515. 


524  APPENDIX 

invested  capital  in  the  case  of  an  individual,  which  will 
be  discussed  in  the  following  paragraphs.  Briefly,  the 
invested  capital  in  such  cases,  consists  of  (a)  the  actual 
cash  paid  into  the  trade  or  business,  (b)  the  actual  cash 
value  of  tangible  property  paid  into  the  trade  or  busi- 
ness, (c)  the  actual  cash  value  of  patents,  copyrights, 
good-will,  trade-marks,  trade-brands,  franchises,  or  other 
intangible  property,  paid  into  the  trade  or  business,  at 
the  time  of  such  payment,  if  payment  was  made  therefor, 
specifically  as  such,  in  cash  or  tangible  property,  not  to 
exceed  the  actual  cash  or  actual  cash  value  of  the  tangible 
property  bona  fide  paid  therefor  at  the  time  of  such 
payment. 

Actual  Cash  Paid  Into  the  Trade  or  Business. 
This  would  seem  to  include  any  amount  of  cash  used  or 
employed  by  the  individual  in  the  trade  or  business  with 
respect  to  which  the  income  is  taxed.  Where  an  in- 
dividual uses  in  his  business  large  sums  of  his  money  at 
various  times  of  the  year,  and  invests  the  same  outside 
of  his  business  at  other  times,  it  seems  that  the  amounts 
should  be  considered  as  invested  capital  in  proportion  to 
the  time  they  are  employed  in  the  business.  Thus,  if  a 
sum  is  employed  in  the  business  for  six  months  each 
year  it  should  be  included  as  invested  capital  for  each 
of  those  months  in  order  to  ascertain  the  average  invested 
capital  for' the  year. 

Tangible  Property  Paid  Into  the  Trade  or  Busi- 
ness. This  would  seem  to  mean  the  tangible  property 
owned  by  the  individual  and  used  in  the  trade  or  busi- 
ness with  respect  to  which  the  tax  is  imposed.  If  such 
property  was  first  employed  in  the  business  at  some  time 
prior  to  January  1,  1914,  the  actual  cash  value  as  of 


THE  WAR  EXCESS  PROFITS  TAX  525 

January  1,  1914,  may  be  considered  as  invested  capital. 
If  tirst  employed  at  a  time  subsequent  to  that  date  the 
actual  cash  value  at  the  time  it  was  so  first  employed  is, 
apparently,  the  amount  which  may  be  included  as  in- 
vested capital. 

Intangible  Property  Paid  Into  the  Trade  or  Busi- 
ness. Patents,  copyrights,  good-will,  trade-marks,  trade- 
brands,  franchises,  or  other  intangible  property  may  be 
considered  as  invested  capital  only  if  payment  was  made 
therefor,  specifically  as  such,  in  cash  or  tangible  property. 
The  amount  which  may  be  taken  as  invested  capital  is  the 
actual  cash  value  of  such  intangible  property,  at  the  time 
of  such  payment,  not  to  exceed  the  actual  cash  or  actual 
cash  value  of  the  tangible  property  ho)ia  fide  paid  there- 
for at  the  time  of  such  payment.  Literally,  this  means 
that  the  actual  cash  paid  for  such  property  may  not  be 
considered  as  invested  capital  if  the  actual  cash  value  of 
the  property  was  less.  Therefore  one  who,  through  lack 
of  shrewdness  or  because  of  necessity,  has  paid  more 
for  such  property  than  its  actual  cash  value,  the  law  will 
penalize  him  byvpermitting  only  the  actual  cash  value  to 
be  considered  as  invested  capital,**  As  an  illustration 
of  the  practical  effect  of  this  provision,  let  us  assume 
that  an  individual  is  engaged  in  manufacturing  under  a 
patent  of  his  own  invention,  and  that  this  patent  has  had 
a  recognized  actual  cash  value  of  more  than  a  million 
dollars  for  a  period  of  five  years  in  the  past.  Under  the 
law  he  is  permitted  to  use  no  part  of  the  value  of  such 
patent  in  ascertaining  his  invested  capital.    But  if  he 

*«  A  practical  interpretation  would  be  that  the  actual  cash  paid 
for  such  property  is  the  actual  cash  value  thereof,  but  the  extreme 
caution  of  the  Conference  Committee  in  framing  this  clause  per- 
mits of  the  literal  interpretation  indicated  in  the  text. 


526  APPENDIX 

should  form  a  corporation  and  transfer  the  patent  to  the 
corporation,  for  stock  of  a  par  value  of  one  million 
dollars,  the  corporation  may  include  in  its  "invested 
capital ' '  one  million  dollars,  with  respeet  to  such  patent, 
since  the  law  expressly  provides  that  the  invested  capital 
of  a  corporation  shall  include  the  actual  cash  value  of 
patents  paid  in  for  stock,  at  the  time  of  such  payment, 
but  not  to  exceed  the  par  value  of  such  stock  at  the  time 
of  such  payment.*® 

Invested  Capital  of  Non-Resident  Aliens.  .A  non- 
resident alien  is  required  by  the  law  to  ascertain  his 
"entire  invested  capital"  in  the  manner  indicated  in  the 
preceding  paragraphs,  and  his  ' '  invested  capital ' '  for  the 
purpose  of  this  law  is  that  proportion  of  the  entire  in- 
vested capital  which  his  net  income  from  sources  witliiu 
the  United  States  bears  to  his  entire  net  income.^® 

Nominal  Capital.  The  law  provides  that  a  flat  rate 
of  8%  shall  be  impased  in  cases  where  a  business  or  trade 
has  no  invested  capital,  or  not  more  than  a  nominal 
capital.^^  The  statute  does  not  define  the  meaning  of  the 
term  "nominal  capital,"  but  applying  the  rules  pre- 
scribed for  determining  "invested  capital,"  it  would 
seem  that  an  individual,  corporation  or  partnership  do- 
ing business  entirely  on  borrowed  money  would  have  no 
capital  and  consequently  be  taxable  at  the  flat  rate  of  8^  . 
It  would  seem,  also,  that  if  the  entire  capital  was  invested 
in  stock,  or  in  assets  the  income  from  which,  is  not  sub- 
ject to  this  tax,  there  would  be  no  invested  capital.  Thus, 
an  individual  doing  business  entirely  on  credit  is  t<ixed 

49  Section  207b. 

50  Section  207,  hist  jiaragraph. 
Bisection  209. 


THE   WAR  EXCESS   PROFITS  TAX  527 

at  a  lesser  rate  than  one  doing  business  with  his  own 
•  apital,  but  one  doing  business  largely  on  credit  may  be 
very  severely  penalized,  since  the  small  amount  of  his 
own  capital  invested  in  his  business  may  not  be  con- 
sidereil  merely  nominal.  The  effect  might  be  somewhat 
as-  follows:  If  the  capital  of  a  business  is  one  hundred 
thousand  dollars  and  all  of  it  is  borrowed,  the  business 
has  no  "invested  capital"  and  consequently  the  annual 
income  might  be  subject  only  to  a  tax  of  8%.  If,  how- 
.ver,  $90,000  of  the  capital  is  borrowed,  and  $10,000  is 
l)aid  in  by  tlve  stockholders,  members  or  individual,  as 
the  case  may  be,  there  is  grave  danger  that  the  entire  net 
income  will  be  taxed  at  the  graduated  rates  after  allow- 
ing a  deduction  on  merely  $10,000  of  "invested  capital." 
To  evolve  a  practical  definition  of  the  phrase  "nominal 
capital"  will  be  one  of  the  many  difficulties  of  the  Treas- 
ury "Department  under  this  law.  No  arbitrary  line  can 
he  drawn  l)eyond  which  the  amount  of  capital  is  no 
longer  nominal.  What  may  be  nominal  capital  in  one 
business  may  be  more  than  nominal  in  another.  A  fixed 
ratio  between  income  and  capital  cannot  be  used  to  draw 
the  line,  .since  the  same  amount  of  capital  may  be  merely 
nominal  in  two  businesses,  and  the  earnings  in  one  may 
l>e  much  greater  than  tlie  earnings  of  the  other.  It  would 
seenu  however,  tiiat  a  trade,  business.  oc^*upation  or  pro- 
fession in  which  the  net  income  is  produced  by  the 
activity  of  the  persons  engaged  therein,  and  not  by  the 
use  of  capital,  except  incidentally  to  furnisji  such  per- 
ms with  business  quarters,  tools,  instruments  or  appli- 
inces.  is  one  to  which  the  flat  rate  of  8%  will  apply. 

Deductions,  Krom  its  net  income  for  the  taxable 
year,  a  corporation,  partnership,  or  individual,  domestic 
or  foreign,  citizen,  resident  or  non-resident,  may  deduct 


528  :kPPENDIX 

an  amount  equal  to  the  same  percentage  of  the  invested 
capital  for  the  taxable  year  which  the  average  amount 
of  the  annual  income  of  the  trade  or  business  during  the 
prewar  period  was  of  the  invested  capital  for  the  prewar 
period,  but  not  less  than  7%  nor  more  than  9%  of  the 
invested  capital  for  the  taxable  year.  For  example,  if 
the  average  net  income  during  the  prewar  period  was 
7%,  or  less,  of  the  average  invested  capital  for  that 
period,  the  deduction  for  the  taxable  year  will  be  1%. 
If  the  average  net  income  for  the  prewar  period  was 
over  7%  but  not  over  9%,  the  same  percentage  of  in- 
vested capital  may  be  deducted  for  the  taxable  year.  If 
the  average  net  income  for  the  prewar  period  was  more 
than  9%,  only  9%  of  the  invested  capital  for  the  taxable 
year  may  be  deducted.^''  If  a  corporation  or  partner- 
ship was  not  in  existence,  or  an  individual  was  not 
engaged  in  the  trade  or  business,  during  the  whol^  of 
any  one  calendar  year  during  the  prewar  period,  the 
deduction  is  8%  of  the  invested  capital  for  the  taxable 
year.^*  If  a  corporation  or  partnership,  or  a  citizen  or 
resident  of  the  United  States,  (a)  had  no  net  income 
from  trade  or  business  during  the  prewar  period  or  (b) 
the  percentage  of  net  income  on  invested  capital  was  low, 
as  compared  with  the  percentage,  during  the  same  period, 
of  representative  corporations,  partnerships,  and  individ- 
uals, engaged  in  a  like  or  similar  trade  or  business,  or 
(c)  the  net  income  for  the  prewar  period  cannot  be 
ascertained  to  the  satisfaction  of  the  Secretary  of  the 
Treasury,  the  deduction  for  the  taxable  year  shall  be  the 
same  percentage  as  in  the  case  of  such  representative 
corporations,  partnerships  or  individuals.  For  instance, 
if,  due  to  exceptional  circumstances,  a  particular  busi- 

68  Section  203. 
63  Section  204. 


THE   WAR  EXCESS  PROFITS  TAX  529 

iiess  made  only  7%  on  invested  capital  during  the  prewar 
period,  while  representative  concerns  in  the  same  line  of 
business  made  10%,  the  unfortunate  business  concern 
will  be  allowed  a  deduction  for  the  taxable  year  of  9% 
on  its  invested  capital,  which  is  the  percentage  that  will 
be  allowed  to  the  business  concerns  making  10%  during 
the  prewar  period.  The  percentage  of  net  income  on 
invested  capital  in  each  trade  or  business  is  required  by 
the  law  to  be  determined  by  the  Commissioner  of  Internal 
Revenue,  for  the  calendar  year,  and,  when  applied  to  a 
corporation  or  partnership  which  has  fixed  its  own  fiscal 
year,  the  percentage  determined  by  the  calendar  year 
ending  during  such  fiscal  year  shall  be  used.  The  un- 
fortunate taxpayer  whose  earnings  were  unduly  low  dur- 
ing the  prewar  period  is  required  by  the  law  to  report 
on  that  basis,  but  may  claim  the  benefit  of  the  rate  of 
representative  concerns  by  filing  a  claim  for  abatement 
of  the  amount  by  which  the  tax  so  assessed  exceeds  a  tax 
computed  upon  the  basis  of  the  deduction  determined 
for  representative  concerns.  In  such  event,  collection  of 
that  part  of  the  tax  covered  by  such  claim  for  abatement 
shall  not  be  made  until  the  claim  is  decided,  but  the 
Commissioner  of  Internal  Revenue  may  require  the 
claimant  to  give  a  bond,  conditioned  for  the  payment  of 
any  tax  found  to  be  due,  with  interest  thereon,  and  if 
such  bond  is  not  given  the  full  amount  of  tax  shall  be 
assessed  and  the  taxpayer  be  left  to  find  his  remedy  by  a 
<'laim  for  refund.** 

Specific  Exemption.  In  addition  to  the  deduction 
described  in  the  preceding  paragraph,  a  domestic  cor- 
poration may  also  deduct  the  specific  sum  of  $3,000  from 

54S€etiou  205,  Section  203  (d). 
F.  I.  Tax.— 34 


530  APPENDIX 

its  net  income  for  the  taxable  year.**  A  domestic  part- 
nership, or  a  citizen  or  resident  of  the  United  States,  may 
deduct  the  sum  of  $6,000.*^  A  foreign  corporation, 
foreign  partnersliip,  or  a  non-i'esident  alien  individual, 
is  not  entitled  to  any  specific  exemption,*'''  but  if  the  net 
income  from  sources  within  the  United  States  is  less  than 
$3,000,  no  tax  is  imposed.*^ 

Deductions  in  Case  Invested  Capital  Is  Not  Deter- 
minable. If  the  Secretary  of  the  Treasury  is  unable  in 
any  case  satisfactorily  to  determine  the  invested  capital, 
the  amount  of  the  deduction  in  such  case  shall  be  deter- 
mined by  the  proportion  between  the  deduction  and  the 
net  income  of  representative  concerns  engaged  in  a  like 
or  similar  trade  or  business.  The  law  requires  the  Com- 
missioner of  Internal  Revenue  to  determine  the  propor- 
tion between  the  deduction  and  net  income  in  each  trade 
or  business  and  in  the  case  of  a  corporation  or  partner- 
ship which  has  fixed  its  own  fiscal  year,  the  proportion 
determined  for  the  calendar  year  ending  during  such 
fiscal  year  shall  be  used.** 

Rate  of  Tax.  In  the  case  of  taxpayers  having  in- 
vested capital  the  tax  is  computed  at  the  following 
rates :  ^® 

20%  of  the  amount  of  the  net  income  in  excess  of  the 
deduction  and  not  in  excess  of  15%  of  the  invested 
capital  for  the  taxable  year; 

56  Section  203  (a). 

66  Section  203  (b). 

67  Section  203  (c). 

68  Section  202. 

69  Section  210. 
60  Section  201. 


THE   WAR   EXCESS   PROFITS   TAX  531 

25%  of  the  amount  of  the  net  income  in  excess  of  15% 
and  not  in  excess  of  20%  of  such  capital ; 

35%  of  the  amount  of  the  net  income  in  excess  of  20% 
and  ;iotJn  excess  of  25%  of  such  capital; 

45%  of  the  amount  of  the  net  income  in  excess  of 
25%  and  not  in  excess  of  33%  of  such  capital;  and 

60%  of  the  amount  of  the  net  income  in  excess  of  33% 
of  such  capital. 

Illustrations.  A  corporation  which  has  invested 
capital  of  $100,000 ;  net  income  of  $50,000  for  the  taxable 
year,  and  is  entitled  to  a  deduction  of  9%  on  its  invested 
capital,  would  compute  the  tax  as  follows.  The  amount 
of  the  deduction  would  be  9%  of  $100,000  or  $9,000, 
plus  the  specific  exemption  of  $3,000,  making  a  total  of 
$12,000.  The  20%  rate  would  apply  to  an  amount  of  net 
income  not  in  excess  of  15%  of  the  invested  capital 
($15,000)  less  the  amount  of  the  deduction  ($12,000)  or 
.$3,000.  The  25%  rate  would  apply  to  so  much  of  the 
income  as  exceeded  15%  of  the  capital  and  did  not 
exceed  20%  of  the  capital,  that  is,  $5,000.  The  35% 
rat«  would  apply  to  $5,000  of  the  income  (the  amount  in 
excess  of  20%  and  not  in  excess  of  25%  of  the  invested 
capital).  The  45%  rate  would  apply  to  $8,000  (the 
amount  in  excess  of  25%  and  not  in  excess  of  33%  of  the 
•  apital)  and  the  60%  rate  would  apply  to  the  remainder 
of  the  net  income,    Thus, 

Income 

$1 5,000  —  $1 2,000  =  $3,000 

5.000 

5,000 

8,000 
17,000 

$50,000  $17,400 


Rate 

Amount 

20% 

$     600 

25% 

1,250 

35% 

1,750 

45% 

3,600 

60%, 

10.200 

532  APPENDIX 

Rate  of  Tax  in  Case  of  Nominal  Capital.  In  the  case 
of  a  trade  or  business  having  no  "invested  capital"  or 
not  more  tl^an  a  nominal  capital  a  tax  of  8%  is  imposed 
upon  the  net  income  of  such  trade  or  business,  in  excess 
of  the  specific  exemption  of  $3,000  allowed  to  domestic 
corporations  or  $6,000  allowed  domestic  partnerships 
and  citizens  or  residents  of  the  United  States.  In  the 
case  of  foreign  corporations,  foreign  partnerships  and 
non-resident  aliens  the  tax  is  imposed  upon  the  entire 
net  income  without  any  deduction,^^  unless  such  net 
income  from  sources  within  the  United  States  is  less  than 
$3,000,  in  which  case  no  tax  is  imposed.®^ 

Tax  Paid  Under  Former  Excess  Profits  Tax  Law. 

The  excess  profits  tax  law  of  March  3,  1917,  is  repealed 
by  this  law,  and  any  amount  paid  on  account  of  the  tax 
imposed  by  that  law  is  required  to  be  credited  toward 
the  payment  of  the  tax  imposed  by  this  law.  If  payment 
under  the  former  law  exceeds  the  amount  of  the  tax 
imposed  under  this  law,  the  excess  may  be  refunded 
under  the  provisions  relating  to  the  refund  of  taxes.®' 

Annual  Returns.  Every  foreign  partnership  having 
a  net  income  of '$3,000  or  more  for  the  taxable  year,  and 
every  domestic  partnership  having  a  net  income  of 
$6,000  or  more  for  the  taxable  year  is  required  to  file  a 
return  annually,  at  the  same  time  and  in  the  same  man- 
ner as  is  prescribed  for  income-tax  returns  under  the 
1916  Law.  Partnerships  having  less  income  than  above 
indicated  are  not  required  to  file  returns  and  are  subject 

61  Section  209. 

62  Section  202. 

63  Section  214. 


THE   WAR   EXCESS   PROFITS  TAX  533 

to  uo  tax.**    Other  taxpayers  will  report  the  information 
necessary  to  assess  this  tax  on  their  income  tax  returns. 

Administrative  Provisions.  All  administrative,  spe- 
cial and  general  provisions  of  law  in  relation  to  the 
assessment,  remission,  collection,  and  refund  of  internal 
revenue  taxes,  not  specifically  repealed,  and  not  incon- 
sistent with  the  provisions  of  this  law,  are  extended  and 
made  applicable  to  all  the  provisions  of  this  law  and  to 
the  tax  imposed  thereby.  All  provisions  of  the  1916  In- 
come Tax  Law,  as  amended,  relating  to  returns  and  pay- 
ment of  the  income  tax,  including  penalties,  are  made 
applicable  to  the  tax  imposed  by  this  law.®*  The  Com- 
miserioner  of  Internal  Revenue  is  authorized  to  make  all 
necessary  regulations  for  carrying  out  the  provisions  of 
this  law,  and  may  require  any  corporation,  partnership, 
or  individual,  subject  to  the  provisions  of  this  law,  to 
furnish  him  with  such  facts,  data,  and  information  as  in 
his  judgment  are  necessary  to  collect  the  tax,®* 

64  Section  211. 
66  Section  212. 
66  Section  213. 


CHAPTER  46 

THE   CAPITAL   STOCK    TAX 

This  tax  is  popularly  known  as  the  capital  stock  tax, 
but  the  statute  describes  it  as  "  a  special  excise  tax  with 
respect  to  carrying  on  or  doing  business."^  The  tax 
is  imposed  upon,  "Every  corporation,  joint-stock  com- 
pany or  association,  now  or  hereafter  organized  in  the 
United  States  for  profit  and  having  a  capital  stock  repre- 
sented by  shares,  and  every  insurance  company,  now  or 
hereafter  organized  under  the  laws  of  the  United  States, 
or  any  state  or  territory  of  the  United  States ' '  and  upon, 
"Every  corporation,  joint-stock  company  or  association, 
or  insurance  company,  now  or  hereafter  organized  for 
profit  under  the  laws  of  any  foreign  country  and  engaged 
in  business  in  the  United  States."  The  tax  is  imposed 
for  the  privilege  of  carrying  on  or  doing  business  for  the 
taxable  year  and  is  payable  in  advance  by  every  taxable 
corporation  engaged  in  business  during  any  part  of  the 
preceding  year. 

Definitions.  The  word  "corporation"  as  used  in  this 
chapter  means,  unless  otherwise  stated,  a  corporation, 
joint-stock  company,  association,  or  insurance  company. 
The  phrase  "taxable  year"  is  the  fiscal  year  of  the  Gov- 
ernment beginning  July  one  of  each  calendar  year  and 
ending  on  the  last  day  of  June  of  the  year  following. 

1  Act  of  September  8,  1916,  §  407. 

534 


THE   CAPITAL  STOCK  TAX  535 

The  phrases  "preceding  year"  and  "preceding  taxable 
year"  as  used  in  the  Statute  mean  the  twelve-month 
period  ending  June  30,  preceding  the  taxable  year. 

Domestic  Corporations  Subject  to  the  Tax.  The  tax 
applies  to  corporations,  joint-stock  companies  or  associa- 
tions organized  in  the  United  States,  provided  they  are 
(a)  organized  for  profit,  (b)  Kave  capital  stock  repre- 
sented by  sliares,  (c)  were  engaged  in  business  during 
the  preceding  taxable  year,  and  (d)  are  not  exempt 
organizations  under  the  provisions  of  Section  11  of  the 
1916  Income  Tax  Law.*  It  should  be  noted  that  the 
law  applies  not  only  to  corporations  but  to  all  associations 
"organized  in  the  United  States"  and  in  this  respect 
seems  to  be  broader  in  its  scope  than  the  1909  Law, 
which  wa,s  construed  to  apply  only  to  corporations,  joint- 
stock  companies  or  associations  "organized  under  the 
laws  of  the  United  States  or  of  any  state  or  territory  of 
the  United  States  or  under  the  Acts  of  Congress  applic- 
able to  Alaska  or  the  District  of  Columbia. "  '  It  was 
apparently'  the  intent  of  Congress  to  make  this  law  apply 
to  associations  which  were  held  not  to  be  taxable  under 
the  1909  Law,  because  not  organized  under  some  statute.* 

*  For  a  discussion  of  corporations  exempt  from  tax  under  the 
1916  Income  Tax  Law,  see  Chapter  15. 

8  Act  of  August  5,  1909,  $  38. 

♦  It.  was  the  intention  of  Congress  to  embrace  within  the  1909 
Law  only  such  corporations  and  joint-stock  associations  as  arc 
organized  under  some  statute  or  derived  from  that  source  some  , 
•luality  or  benefit  not  existing  at  the  common  law.  (Eliot  v.  Free- 
man, 220  T^.  S.  178.)  This  was  a  case  involving  the  so-called 
"Massachusetts  Real  Estate  Trusts"  and  the  Treasury  Depart- 
ment has  indicated  that  it  will  not  hold  such  trusts  subject  to  the 
capital  stock  tax.  It  seems,  nevertheless,  that  Congress  had  a 
definite  intention  to  include  such  organizations  bj  using  the  phrase 


536  APPENDIX 

The  language  of  the  two  laws  not  being  identical, 
decisions  under  the  1909  Law  are  not  controlling  with 
respect  to  this  law.  It  seems,  rather,  that  any  corpora- 
tion or  association  subject  to  the  1916  Income  Tax  Law 
would  be  subject  to  the  capital  stock  tax  law  (providing 
the  other  conditions  co-exist)  since  the  language  of  Sec- 
tion 10(a)  of  the  1916  Law  has  phraseology  very  similar 
to  the  language  of  this  law.* 

Insurance  Companies.  It  seems  that  an  insurance 
company  in  order  to  be  subject  to  this  tax  must  be  organ- 
ized under  the  laws  of  the  United  States,  or  any  state 
or  territory  of  the  United  States.  An  insurance  com- 
pany not  organized  under  sonde  statute  would  not  be 
subject  to  the  tax  although  it  may  have  capital  stock 
represented  by  shares.  If  organized  under  a  statute  the 
other  elements  must  co-exist,  that  is,  it  must  have  been 
organized  for  profit,  must  be  engaged  in  business  and 
must  not  be  one  of  the  classes  of  corporations  specifically 
enumerated  as  exempt  in  the  1916  Income  Tax  Law. 
Although  the  law  imposes  the  tax  on  insurance  com- 
panies without  reference  to  whether  or  not  they  have 
capital  stock  represented  by  shares  it  has  been  held  by 
the  Treasury  Department,  inasmuch  as  the  basis  of  tax 
is  the  fair  value  of  the  stock  of  the  corporation,  that 
mutual  insurance  companies  and  other  associations  not 
having  capital  stock  represented  by  shares  will  be  held 

•  "organized  in  the  United  States"  instead  of  the  phrase  "organ- 
ized under  the  laws  of  the  United  States  or  of  any  state  or  terri- 
tory of  the  United  States,"  which  latter  phrase  was  used  in  the 
1909  Law  and  was  the  precise  language  on  which  this  case  was 
decided. 

B  For  rulings  under  the  1916  Law  on  joint-stock  companies  and 
associations  see  Chapter  12. 


THE  CAPITAL  STOCK  TAX  537 

exempt  from  the  tax,  in  the  absence  of!  a  basis  for  the 
computation  thereof.® 

Holding  Companies.  A  holding  company,  as  such,  is 
not  exempt  from  this  tax.  The  Treasury  Department 
has  held  that  a  holding  company  organized  in  the  United 
States  for  the  purpose  of  acquiring  and  holding  capital 
stock  of  subsidiaiy  companies,  and  actually  engaged  in 
holding  such  stock,  voting  thereon,  receiving  dividends 
thereon,  and  distributing  money  among  its  own  share- 
holders, is  engaged  in  business  and  is  subject  to  this  tax.'' 
Both  holding  companies  and  their  subsidiary  corporations 
are  required  to  file  returns  and  pay  the  tax,  no  deduc- 
tion being  allowed  to  the  holding  corporation  for  the 
tax  assessed  on  its  subsidiary.' 

Subsidiary  Companies.  A  subsidiary  company  is 
taxed  on  the  fair  value  of  its  capital  stock,  although  the 
parent  company  is  also  taxed  on  the  value  of  its  capital 
stock,  represented  by  the  stock  of  such  subsidiary.® 

It  has  been  held  that  in  order  to  determine  the  fair 
value  of  capital  stock  of  subsidiary  companies,  the  fair 
value  of  the  capital  stock  of  the  parent  company,  deter- 
mined from  the  prices  list-ed  on  an  exchange  or  from 
actual  sales,  may  be  apportioned  among  the  subsidiaries 
according  to  the  amount  of  net  profits  earned  by  each 
during  the  year,  making  due  allowance  for  the  amount 
of  net  profits  earned  by  the  parent  corporation  from 
actual  operations  and  investments  or  holdings  in  stock  of 
companies  other  than  its  subsidiaries.    As  an  illustration, 

BT.  D.  2364. 

7T.  D.  2429. 

8T.  D.  2503. 

»T.  D.  2493. 


538  APPENDIX 

assume  that  the  fair  value  of  the  capital  stock  of  a  parent 
company  is  $5,000,000  and  that  it  derived  one-fifth  of  its 
ome  during  the  preceding  year  from  operations  and 
inve-^traents  in  securities,  other  than  stock  of  its  two 
subsidiaries.  In  such  case,  one-fifth  of  the  fair  value  of 
its  capital  stock  will  be  ascribed  to  capital  used  in  its 
operations  and  outside  investments,  four-fifths,  or  $4,- 
000,000,  being  ascribed  to  the  capital  stock  of  the  sub- 
sidiaries. Assume  further,  that  one  of  the  subsidiaries 
had  net  income  of  $600,000  and  the  other  had  net  income 
of  $200,000.  The  aggregate  net  income  of  the  subsidiaries 
would  be  $800,000,  three-fourths  of  which  would  be 
earned  by  the  one  and  one-fourth  by  the  other.  Conse- 
quently, the  value  of  the  capital  stock  of  the  one  would 
he  three-fourths  of  $4,000,000,  and  the  value  of  the  capi- 
tal stock  of  the  other  would  be  one-fourth,  or  $3,000,000 
and  $1,000,000  Tespectively.  Where  the  value  of  the 
stock  of  a  subsidiary  company  is  determined  on  this  basis, 
the  Treasury  Department  requires  a  statement  showing 
the  fair  value  of  capital  stock  of  the  parent  company,  its 
earnings  for  the  preceding  year,  the  amount  of  such 
earnings  derived  from  operations  and  outside  invest- 
ments, and  the  net  earnings  of  each  subsidiary.^® 

Corporations  Not  Engaged  in  Business.  Since  this  is 
a  tax  with  respect  to  the  carrying  on  or  doing  business 
by  a  corporation,  it  follows  that  only  such  corporations 
as  are  engaged  in  business  are  subject  to  the  tax.  The 
meaning  of  the  term  "engaged  in  business"  was  defined 
by  a  number  of  decisions  under  the  1909  Law,  with  par- 
ticular reference  to  cases  where  corporations  had  eeascl 
to  do  business.    Thus,  it  was  held  that  where  a  corpora- 

10  T.  D.  2493  as  amended  by  T.  D.  2509. 


THE  CAPITAL  STOCK  TAX  589 

tiuii.  originally  organized  for  the  purpose  of  owning  and 
renting  an  office  building,  leased  its  property  for  130 
years,  its  sole  authority  under  its  charter  thereafter  being 
to  hold  the  title  subject  to  the  lease  and  to  receive  and 
tlistribute  the  rentals  which  might  accrue  under  the 
terms  of  the  lease,  or  the  proceeds  of  any  sale  of  the  land 
if  it  should  be  sold,  was  not  engaged  in  business  within 
the  meaning  of  that  law.**  In  another  case,  it  was  held 
that  a  railroad  corporation  which  had  leased  its  prop- 
erty for  a  terra  of  years,  and  parted  with  its  control  and 
management,  maintaining,  however,  its  corporate  organ- 
ization, collecting  rentals  from  the  lessee,  and  distributing 
the  same  among  its  stockholders,  was  not  engaged  in 
Ijusiness.**  Where,  however,  a  corporation  was  organized 
to  build  and  lease  property,  the  fact  that  it  had  leased 
all  of  its  property  and  did  nothing  except  collect  and 
distribute  the  rents,  did  not  exempt  it  from  the  tax,  since 
such  collection  and  distribution  of  rents  from  the  leased 
property  was  the  business  for  which  it  was  organized.** 
These  and  other  decisions**  will  be  followed  by  the 

11  Zonne  v.'  Minneapolis  Syndicate,  220  U.  S.  187.  In  a  later 
case  it  was  held  that,  although  a  corporation  might  have  power 
to  do  business  under  its  charter,  if  it  had  .leased  all  its  property 
and  was  merely  collecting  rent  it  was  not  engaged  in  business. 
U.  S.  V.  Emery,  etc.  Co.,  237  U.  S.  28. 

18  McCoach  V.  Mine  Hill  &  Schuylkill  Haven  R.  R.  Ck).,  228  U.  8. 
295. 

IS  Rio  Grande  Junction  Ry.  Co.  v.  U.  S.,  51  Ct.  Cls.  274. 

14  Other  cases  arising  under  the  1909  Law  are  Anderson  v.  Mor- 
ris &  Essex  R.  R.  Co.,  216  Fed.  83 ;  Cambria  Steel  Co.  v.  McCoach, 
225  Fed.  278;  Jasper,  etc.  Ry.  Co.  v.  Walker,  238  Fed.  533;  Lewel- 
lyn  V.  Pittsburgh,  et.  R.  R.  Co.,  222  Fed.  177;  McCoach  v.  Con- 
tinental Passenger  Ry.  Co.,  233  Fed.  976;  Miller  v.  Snake  River 
Valley  R.  R.  Co.,  223  Fed.  946;  New  York  Central  v.  Gill,  219  Fed. 
184;  New  York  Mail,  etc.  Co.  v.  Anderson,  234  Fed.  590;  Phila- 
delphia, etc.   R.  R.  Co.  v.  Lederer,  242  Fed.  492;    Philadelphia 


540  APPENDIX 

Treasury  Department  where  the  decisions  are  by  the 
United  States  Supreme  Court  or,  if  by  the  lower  courts, 
have  been  acquiesced  in  by  the  Department.  Corpora- 
tions organized  for  the  purpose  of  buying,  owning,  ex- 
ploring, developing,  leasing,  improving,  selling  and  deal- 
ing in  lands,  mining  properties,  tenements,  and  heredita- 
ments, are  considered  to  be  engaged  in  business  if  they 
perform  any  of  their  powers.  It  is  not  necessary  that 
such  a  corporation  be  an  operating  company  in  order  to 
be  taxable  under  this  law.  If  a  corporation  is  doing 
any  one  of  the  several  things  it  is  authorized  to  do,  by  its 
charter,  it  is  "engaged  in  business"  and  subject  to  this 
tax.^^  Corporations  in  the  possession  and  control  of 
receivers  appointed  by  a  court  are  not  engaged  in  busi- 
ness during  the  period  of  the  receivership.^^ 

Engaged  in  Business  During  Preceding  Taxable  Year. 

A  corporation  is  not  subject  to  tax  in  any  taxable  year 
unless  these  two  conditions  co-exist:  (a)  it  must  have 
been  carrying  on  business  during  some  part  of  the  pre- 
ceding year,  and  (b)  it  must  be  carrying  on  business  in 
the  taxable  year.  It  is  not  necessary,  however,  that  the 
corporation  should  have  been  engaged  in  business  during 
the  entire  preceding  year.  If  it  was  engaged  in  business 
at  some  time  during  the  preceding  year,  the  length  of 
time  has  no  bearing  upon  the  amount  of  tax  due.  A 
corporation  commencing  business  on  the  last  day  of  the 
preceding  year  is  held  by  the  Treasury  Department  to 

Traction  Co.  v.  MeCoacli,  224  Fed.  800;  Public  Service  Electric 
Co.  V.  Herold,  229  Fed.  902;  Traction  Companies  v.  Collector  of 
Internal  Rev.,  223  Fed.  984;  Wilkes-Barre,  etc.  Traction  Co.  v. 
Davis,  214  Fed.  551. 

16  T.  D.  2457. 

16  T.  D.  2424. 


THE   CAPITAL  STOCK   TAX  541 

be  subject  to  the  tax  to  the  same  extent  as  though  it  had 
been  engaged  in  business  for  the  entire  year,  and  the  full 
rate  of  tax  for  the  taxable  year  is  imposed.^'' 

Ina,ctive  Corporations.  A  corporation  not  engaged  in 
business  at  the  beginning  of  the  taxable  year  is  not  re- 
quired to  file  a  return  or  pay  a  tax,  although  it  may  have 
been  engaged  in  business  during  a  part  of  the  preceding 
year.  If  such  corporation  resumes  business  at  any  time 
during  the  taxable  year,  it  will  be  required,  at  that  time, 
to  make  a  return  and  pay  the  tax  for  the  proportion  of 
the  year  in  which  it  intends  to  do  business.  In  such 
fases  the  tax  is  computed  proportionately  from  the  first 
day  of  the  month  in  which  it  engages  in  business  to  the 
end  of  the  taxable  year.  Thus,  if  a  corporation  was 
engaged  in  business  during  some  part  of  the  taxable  year 
beginning  July  1,  1916,  and  ending  June  30,  1917,  but 
was  not  engaged  in  business  on  July  1,  1917,  it  was 
required  to  file  no  return  and  pay  no  tax  at  that  time. 
If  it  subsequently  engaged  in  business  in  September, 
1917,  the  return  was  required  to  be  filed  and  the  tax  be 
paid  at  that  time,  for  ten-twelfths  of  the  full  year.  If  an 
inactive  corporation  was  not  engaged  in  business  during 
any  part  of  the  preceding  year,  it  is  not  taxed  in  the  year 
it  resumes  activity,  but  makes  a  return  and  pays  the  tax 
at  the  beginning  of  the  next  taxable  year. 

Corporations  Ceasing  to  Do  Business  During  the  Tax- 
able Year.  If  a  corporation  has  paid  this  tax  at  the 
beginning  of  a  taxable  year  and  ceases  to  do  business 
before  the  close  of  that  year,  no  refund  of  any  amount 
of  the  tax  is  allowed  for  that  portion  of  the  year  iu 
which  it  does  no  business." 

"  T.  D.  2417. 

Jl  See  §  3237,  Rev.  Stat. 


542  APPENDIX 

Basis  of  Tax.  The  basis  of  the  tax  in  the  case  of  all 
domestlG  corporations  is  ''the  fair  average  value  of  the 
capital  stock  for  the  preceding  year/'  The  tax  is  im- 
posed upon  the  fair  value  of  the  entire  capital  stock  of 
domestic  corporations,  no  deduction  being  allowed  in 
cases  where  a  part  of  the  capital  is  invested  in  foreign 
countries.^® 

Fair  Value  of  Capital  Stock.  The  law  provides  in  the 
case  of  domestic  corporations,  that  in  estimating  the 
value  of  capital  stock,  the  surplus  and  undivided  profits 
shall  be  included;  provided,  that  in  the  case  of  insur- 
ance companies  such  deposits  and  reserve  funds  as  they 
are  required  by  law  or  contract  to  maintain  or  hold  for 
the  protection  of  or  payment  to  or  apportionment  among 
policyholders  shall  not  be  included  in  estimating  the 
value  of  the  capital  stock,  surplus  and  undivided 
profits.^**  The  Treasury  Department  has  prescribed 
three  methods  by  which  the  fair  value  of  the  capital  stock 
may  be  determined :  Case  1,  where  the  stock  is  listed  on 
an  exchange ;  Case  2,  where  the  stock  is  not  listed  on  any 
exchange,  but  sales  thereof  have  been  actually  made,  and 
the  price  paid  for  the  stock  is  known  to  the  officer  making 
the  return,  or  can  be  discovered  by  him,  and  Case  3, 
where  the  stock  is  not  listed  and  no  actual  sales  have  been 
made,  or  if  the  price  at  which  sales  have  been  made  is 
not  known  to  the  officer  making  the  return.^^     Cases  1 

19  T.  D.  2417. 

20  Act  of  September  8,  1916,  §  407,  The  methods  prescribed  by 
the  Treasury  Department  for  ascertaining  the  fair  value  of  capital 
stock  eliminate  such  deposits  and  reserve  funds  maintained  or 
held  in  the  United  States  and  the  amount  thereof  is  not  deducted 
after  computing  the  value  of  the  stock  by  any  one  of  the  three 
methods  described  below.     (T.  D.  2503.) 

21  T,  D,  2364, 


THE  CAPITAL  STOCK  TAX  548 

iiiitl  2  present  comparatively  few  difficulties  and  cover  a 
comparatively  small  number  of  corporations.  Case  3 
has  more  general  application.  The  rules  applicable  to 
each  of  the  three  rases  are  discussed  below. 

Increase  or  Decrease  op  Capital  Stock.  If  the  cor- 
poration has  increased  or  decreased  its  capital  stock  dur- 
ing the  preceding  year,  a  statement  should  be  attached  to 
the  back  of  its  return  setting  forth  the  number  of  shares 
of  stock  outstanding  each  month  with  the  fair  average 
value  of  the  stock  for  that  month  computed  under  one  of 
the  three  cases.** 

Capital  Stock  Outstanding.  In  estimating  the  value 
of  the  capital  stock  outstanding  so-called  "treasury 
stock"  which  has  once  l)een  issued  and  thereafter  ac- 
quired by  the  company  for  value  is  considered  as  capital 
outstanding.  Preferred  stock  and  common  stock  are  to 
be  considered  in  es:ti mating  the  total  fair  average  value.** 

Case  1.  If  the  stock  is  listed  on  any  exchange  its 
fair  value  is  determined  by  adding  the  quoted  highest 
bid  price  for  the  stock  on  the  last  business  day  of  each 
month  during  the  preceding  fiscal  year  (or  if  no  bid 
price  was  quoted  on  the  last  day,  then  the  latest  day  in 
the  month  on  which  a  bid  price  was  quoted),  and  divid- 
ing by  twelve,  the  result  being  the  average  bid  price  per 
share  for  that  year.**  A  corporation  may.  if  it  prefers, 
average  the  fair  value  throughout  the  entire  fiscal  year 
by  showing  on  a  statement,  attached  to  the  back  of  the 
return,   the   highest  bid   price   for  stock   on   each   day 

22  T.  D.  2503. 

23  Letter  from  Treasury  Department  dated  December  19,  1916. 

24  T.  D.  2.'?64. 


544  APPENDIX 

throughout  the  year.'^^  Where  stock  listed  on  an  ex- 
change is  subject  to  great  fluctuation,  and  the  prices  do 
not  indicate  the  fair  value  of  the  stock,  the  corporation 
may  attach  a  statement  to  its  return  setting  forth  the 
reasons  why  the  bid  prices  are  not  considered  an  indica- 
tion of  the  value  of  the  stock,  which  statement  will  be 
taken  into  consideration  when  assessment  of  the  tax  is 
made.^® 

Case  2.  If  the  stock  is  not  listed  on  any  exchange,  but 
sales  thereof  have  been  actually  made,  and  the  price  paid 
for  the  stock  is  known  to  .the  officer  making  the  return, 
or  can  be  discovered  by  him,  the  average  price  at  which 
sales  were  made  during  the  preceding  fiscal  year  shall  be 
the  determining  factor  in  ascertaining  the  fair  value  per 
share.^'''  Corporations  estimating  the  fair  value  of  their 
stock  under  Case  2,  are  required  to  take  "the  average 
price  at  which  sales  were  made  during  the  preceding 
fiscal  year"  and  not  the  average  selling  price  per  share. 
Thus,  if  ten  shares  were  sold  at  $100,  and  one  thousand 
shares  were  sold  at  $70,  the  "average  price  at  which 
sales  were  made"  would  be  $85.  The  average  selling 
price  in  such  case  would  be  $70.29,  but  this  price  will 
not  be  accepted  as  an  average  fair  value.  A  corporation 
protesting  against  the  computation  of  the  value  of  stock 
by  this  method  may  file  a  statement  with  its  return  set- 
ting forth  the  facts  in  detail  and  requesting  the  Collector 
to  bring  the  case  to  the  attention  of  the  Treasury  Depart- 
ment when  the  return  is  forwarded  to  that  Department 
for  audit.^'    When  sales  have  been  made  during  the  year 

26  T.  D.  2503. 

26  Letter  from  Treasury  Department  dated  January  22,  1917. 

27  T.  D.  2364. 

28  T.  D.  2423. 


THE   CAPITAL.  STOCK   TAX  545 

iiiuler  circuiiustaiiees  whieli  do  uot  indicate  the  true  value; 
of  the  stock,  the  prices  which  were  paid  should  be  stated, 
and.  iu  addition,  the  value  of  the  stock  may  be  estimated 
under  Case  3,  a  statement  being  attached  to  the  return 
explaining  why  the  tigures  in  Case  2  do  not  indicate  the 
fair  average  value  of  the  stock.*®  If  there  are  not  enough 
sales  to  establish  a  basis  for  eslimating  the  fair  value  of 
the  total  capital  stock,  the  corporation  will  be  required 
to  till  out  Case  3.*» 

Case  3.  If  Case  1  and  Case  2  can  not  be  applied,  viz., 
the  stock  is  not  listed  on  any  exchange,  and  no  actual 
sales  have  been  made  during  the  preceding  fiscal  year, 
or  if  the  price  at  which  sales  have  been  made  is  not 
known  to  the  officer  making  the  return,  the  fair  average 
value  of  the  capital  stock  shall  be  estimated,  and  the 
surplus  and  undivided  profits  for  the  preceding  fiscal 
year  will  be  taken  into  consideration  as  required  by  the 
statute,  as  well  as  the  nature  of  the  business,  its  earning 
capacity  and  average  dividends  paid,  or  profits  earned 
during  the  preceding  five  years.'^  The  Treasury  De- 
partment re(|uires  the  return  to  show  the  amount  of  net 
income  reported  on  the  federal  income  tax  returns  for 
five  preceding  years  and  the  inimber  of  shares  outstand- 
ing on  December  31  of  each  of  such  years,  togetlier  with 
the  percentage  of  earnings  on  each  share  of  stock.  A 
10%  earning  capacity,  so  determined,  is  taken  as  prima 
facie  evidence  that  the  stock  is  worth  par.  If  the  earn- 
ing capacity  is  more  or  less  than  10%  the  estimated  fair 
value  per  share  is  taken  to  be  correspondingly  more  or 
loss  than  par.     Thus,  if  the  earning  capacity  is  shown 

89  letter  from  Treasury  Department  dated  January  22,  1917. 
SOT.  D.  2503. 
31  T.  D.  2364. 

P.  I.  Tax— 35 


546  .  APPENDIX 

to  be  8%  the  tax  will  be  assessed  on  a  "fair  average 
value"  of  80%  of  par.  If  the  earning  capacity  is  shown 
to  be  12%  the  fair  average  value  is  taken  to  be  120%  of 
par.  The  assessment  is  based  on  this  prima  facie  valua- 
tion unless  the  corporation  submits  proof  that  such 
valuation  is  not  fair  and  equitable.  The  estimated  fair 
value  per  share  having  been  ascertained,  as  above,  such 
sum  is  multiplied  by  the  number  of  shares  outstanding 
on  June  30  preceding  the  time  of  making  the  return,  in 
order  to  ascertain  the  fair  value  of  the  capital  stock.  If, 
however,  the  number  of  shares  outstanding  during  the 
year  has  varied,  the  average  number  of  shares  outstand- 
ing may  be  taken  instead  of  the  total  number  of  shares 
outstanding  on  June  30.  Thus,  if  a  corporation  has  500 
shares  outstanding  for  four  months,  and  1,000  shares 
outstanding  for  eight  months,  the  average  number  of 
shares  outstanding  for  the  year  will  be  the  total  of  the 
number  outstanding  at  the  end  of  each  month  divided  by 
twelve,  or  833  shares.  Should  the  officers  of  a  corpora- 
tion consider  that  a  10%  earning  capacity  does  not  war- 
rant a  valuation  of  par  for  their  stock  they  may  attach 
to  the  return  a  statement  under  oath,  reciting  the  reasons 
for  their  conclusion  and  giving  a  statement  of  the  assets 
and  liabilities  as  of  June  30  preceding,  or  as  of  the  end 
of  their  last  fiscal  year,  and  these  factors  will  be  given 
consideration  in  making  the  assessment. 

Exceptions  to  Case  3.  Corporations  that  have  no 
regular  earnings,  such  as  companies  organized  for  the 
purpose  of  developing  and  selling  timberland,  mining 
property,  and  other  real  property,  and  corporations  that 
have  earned  no  profits  in  the  past  five  years  or  have  only 
been  engaged  in  business  one  or  two  years,  can  not  very 
well  estimate  the  value  of  the  stock  from  their  earning 


THE   CAPITAL  STOCK   TAX  547 

capacity.  It  has  also  been  found  that  the  earning  capac- 
ity is  not  an  equitable  method  in  computing  the  fair 
value  of  real  estate  and  investment  companies.  Such 
corporations  are  permitted,  therefore,  to  file  a  detailed 
statement,  attached  to  the  back  of  the  return,  showing 
their  assets  and  liabilities  as  of  June  30,  last,  or  as  of 
the  end  of  their  last  fiscal  year,  and  may  estimate  the  fair 
value  of  the  stock  from  the  book  value  thereof.'*  If  the 
l)Ook  value  of  assetii  is  fictitious  and  does  not  represent 
the  true  value  of  the  property,  this  fact  should  be  fully 
explained  on  the  statement  and  the  true  value  of  the 
property  should  be  stated,  together  with  any  other  data 
as  to  the  hazards  of  the  business  or  conditions  peculiar 
to  the  business  which  in  the  judgment  of  the  officers 
tends  to  affect  the  value  of  the  stock. 

Exemption.  After  computings  the  fair  value  of  the 
capital  stock,  the  law  permits  an  exemption  of  $99,000, 
that  is,  the  tax  is  imposed  only  upon  the  fair  value  of 
the  capital  stock  in  excess  of  $99,000.'' 

Rate  of  Tax.  The  tax  is  an  amount  equivalent  to 
fifty  cents  for  each  one  thousand  dollars  of  the  fair  value 
of  the  capital  stock.  It  is  computed  on  each  full  one 
thousand  dollars  and  not  on  any  fractional  part  thereof.'* 
Thus,  if  a  corporation  has  a  fair  value  of  capital  stock 
of  $186,656,  the  fraction  over  $186,000  is  eliminated  in 
computing  the  tax. 

Deduction  of  Munition  Manufacturers'  Tax.  If  the 
corporation  has  paid  the  tax  imposed  under  the  Act  of 

M  T,  D.  2503,  Letter  from  Treasury  Department  dated  August 
17,  1917. 

33  Act  of  September  8,  1916,  |  407. 

34  T.  r>.  2364. 


548  APPBNDEX 

September  8,  1916,  ou  inuiiition  manufacturers,  the 
amount  of  such  tax  may  be  deducted  from  the  tax  found 
to  be  due  under  this  Act  and  only  the  remainder,  if  any, 
will  be  payable.  The  deduction  of  the  munition  manu- 
facturers' tax  is  allowed  only  with  respect  to  such  tax 
actually  paid  since  the  making  of  the  last  previous  re- 
turn. No  deduction  can  be  made  for  a  tax  assessed  but 
not  paid  at  the  time  of  making  the  capital  stock  tax 
return.^* 

Tax  Due.  This  tax  is  an  excise  tax  on  the  privilege 
of  doing  business,  similar  to  occupational  taxes  imposed 
on  individuals.  Being  a  privilege  or  occupational  tax, 
it  is  payable  annually,  in  advance,  in  July,  the  beginning 
of  the  Government's  fiscal  year.  The  tax  is  payable  to 
the  collector,  at  any  time  after  July  1,  but  penalties  for 
non-payment  do  not  attach  until  ten  days  after  notice 
and  demand  therefor  has  been  served  by  the  collector 
upon  the  taxpayer.^^ 

Returns.  The  capital  stock  tax  return  is  required  to 
be  filed  in  July  of  each  year.^''^  The  return  is  filed  with 
the  collector  of  the  district  in  which  the  principal  place 
of  business  of  the  corporation  is  located.  Forms  are  sent 
to  taxable  corporations  known  to  collectors,  but  failure 
to  receive  a  blank  form  does  not  relieve  a  corporation 
from  the  penalties  prescribed  by  law  for  failure  to  make 
the  return  within  the  time  required. 

35  T.  D.  2364. 

36  T.  D.  2423.  See  Chapter  36  for  rulings  as  to  notice  and  de- 
mand. 

37  T.  D.  2364.  The  form  to  be  used  by  domestic  corporations 
is  known  as  Form  707. 


THE   CAPITAL  STOCK   TAX  549 

When  Required.  A  return  is  required  of  every  do- 
mestic corporation  engaged  in  business,  having  a  capital 
.stock  is.sued  and  outstanding,  represented  by  sliares,  of 
the  "fair  average  value"  of  $75,000  or  over,  regardless 
of  the  par  value  of  its  capital  stock,  unless  such  corpora- 
tion was  not  engaged  in  business  during  the  preceding 
taxable  year.**  Since  the  Treasury  Department  has 
adopted  an  arbitrary  rule  of  valuing  capital  stock  on  the 
theory  that  a  10%  earning  capacity  makes  the  stock 
worth  par,  a  corporation  may  be  required  to  file  a  re- 
turn, and  be  subject  to  the  penalties  for  failure  so  to  do, 
notwithstanding  that  the  officers  of  the  company  con- 
sider the  stock  to  be  worth  less  than  $75,000.  Thus,  a 
corporation  having  a  capital  stock  outstanding  of  $50,000 
par  value,  on  which  it  earns  15%,  will  be  required  to 
make  a  return,  the  "fair  average  value"  being  150%  of 
par,  according  to  the  rule  laid  down  by  the  Treasury 
Department.  Similarly,  a  corporation  having  $25,000 
par  value  of  stock  outstanding,  on  which  it  earns  30%, 
will  be  required  to  file  a  return.  To  determine  whether 
or  not  a  corporation  .should  file  a  return,  the  percentage 
of  earnings  per  share  should  be  multiplied  by  ten  to 
ascertain  the  percentage  of  value  of  its  shares  over  or 
under  par.  If  this  figure,  multiplied  by  the  number  of 
shares  outstanding,  gives  a  product  of  $75,000  or  more, 
a  return  should  be  filed  in  order  to  avoid  penalties. 

Extension  of  Time.  An  extension  of  time  for  filing 
tlio  capital  stock  return  may  lx»  obtained  in  the  case  of 
sickness  or  absence,  such  extension  not  to  exceed  thirty 

(lays.*® 

3«  T.  D.  2364. 
39  T.  D.  2.364. 


550  APPENDIX 

Penalty  for  Failure  to  Make  Return.  If  a  corporation 
fails  to  make  a  return  on  or  before  the  last  day  of  July 
in  any  year,  the  collector  may  make  a  return  from  such 
information  as  he  can  obtain  through  testimony  or  other- 
wise, and  a  penalty  of  50%  of  the  amount  of  the  tax  so 
found  due  will  be  added,  unless  a  return  is  voluntarily 
made  and  without  notice  from  the  collector  and  it  is 
shown  that  the  failure  to  file  it  was  due  to  a  reasonable 
cause  and  not  to  wilful  neglect.*®  In  case  of  false  or 
fraudulent  return  is  made  the  Commissioner  will  add 
100%  of  the  amount  of  the  tax.  "Every  person  who  car- 
ries on  any  business  or  occupation  for  which  special  taxes 
are  imposed  by  this  title,  without  having  paid  the  special 
tax  therein  provided,  shall,  besides  being  liable  to  the 
payment  of  such  special  tax,  be  deemed  guilty  of  a  mis- 
demeanor, and  upon  conviction  thereof  shall  pay  a  fine 
of  not  more  than  $500,  or  be  imprisoned  not  more  than 
six  months,  or  both,  in  the  discretion  of  the  court."** 
The  50%  penalty  for  delinquency  in  filing  returns,  as 
weU  as  the  specific  penalty  for  carrying  on  business 
without  payment  of  special  tax,  will  be  strictly  enforced 
against  corporations  that  fail  to  file  returns  of  capital- 
stock  tax  within  the  time  prescribed  by  law  or  by  the' 
collector.*^ 

Penalty  for  Delay  in  Paying  Tax.  Upon  failure  to 
pay  the  tax  assessed  within  ten  days  after  notice  and 
demand,  a  penalty  of  5%  of  the  tax  unpaid,  and  interest 

40  T.  D.  2364;  Eev.  Stat.  §  3176,  as  amended.     See  p.  422. 

41  Act  of  September  8,  1916,  §  408,  T.  D.  2364. 

42  For  procedure  in  compromising  the  specific  penalty  see  Chap- 
ter 37. 


THE  CAPITAL  STOCK  TAX  551 

at  the  rate  of  1%  per  month  until  paid,  is  added  to  the 
amount  of  such  tax.*^ 

Foreign  Corporations.  Every  corporation,  joint-stock 
company  or  association,  or  insurance  company,  organ- 
ized for  profit  under  the  laws  of  any  foreign  country  and 
engaged  in  business  in  the  United  States,  is  subject  to 
this  tax,  with  respect  to  the  carrying  on  or  doing  busi- 
ness in  the  United  States  by  such  corporation,  joint-stock 
company  or  association,  or  insurance  company,  the  tax 
being  based  upon  the  capital  invested  in  the  transaction 
of  business  in  the  United  States,  It  is  to  be  noted  that 
a  foreign  corporation  is  not  subject  to  this  tax  merely 
because  it  receives  income  from  sources  within  this  coun- 
try. To  be  taxable,  a  foreign  corporation  must  be  carry- 
ing on  or  doing  business  in  the  United  States  and  must 
have  capital  actually  invested  in  the  transaction  of  such 
business.**  The  chapter  on  foreign  corporations,  in  the 
foregoing  part  of  this  book,  contains  decisions  and 
rulings  which  define  what  is  doing  business  by  foreign 
corporations,  and  such  rulings  and  decisions  have  appli- 
cation to  this  tax.  It  should  be  borne  in  mind,  however, 
that  some  of  the  rulings  with  respect  to  the  taxability  of 
foreign  corporations  under  the  income  tax  law  have  no 
application  to  this  law,  since  this  tax  is  imposed  only 
where  the  foreign  corporation  is  carrying  on  or  doing 
business  in  this  country  and  has  capital  invested  in  the 
transaction  of  such  business.** 

43  See  Chapter  36  for  rules  vith  respect  to  assessment  and  pay- 
ment of  the  tax. 

44  Act  of  September  8,  1916,  (  407. 

46  Laurentide  Co.,  Limited,  v.  Durey,  231  Fed.  223,  and  Bryant 
and  May,  Limited,  t.  Scott,  226  Fed.  875,  are  cases  in  point.  S«« 
p.  178,  supra. 


552  APPENDIX 

Basis  of  T.lx.  In  the  case  of  foreign  corporations,  the 
tax  is  imposed  upon  the  capital  actually  invested  in  the 
transaction  of  its  business  in  the  United  States,  the 
amount  of  the  tax  being  computed  on  the  basis  of  the 
average  amount  of  capital  so  invested  during  the  preced- 
ing year.  Bank  accounts  carried  by  a  foreign  corpora- 
tion in  this  country  are  to  he,  considered  in  computing 
the  amount  of  capital  actually  invested  if  the  money  is 
carried  on  the  books  of  the  corporation  as  capital  invested 
in  its  business  in  this  country,**  but  not  if  the  money  is 
kept  here  merely  for  convenience  or  investment. 

Foreign  Insurance  Companies.  Foreign  insurance 
companies  are  permitted,  by  statute,  to  exclude  from 
capital  actually  invested  in  the  transaction  of  business 
in  the  United  States,  such  deposits  or  reserve  funds  as 
they  are  required  by  law  or  contract  to  maintain  or  hold 
in  the  United  States  for  the  protection  of  or  payment  to 
or  apportionment  among  policyholders.  The  Treasury 
Department  has  held  that  the  amount  of  capital  invested 
in  the  transaction  of  business  in  the  United  States  by 
foreign  insurance  companies  is  the  amount  of  "surplus 
to  policyholders,"  as  shown  by  the  conventional  form  of 
report  to  State  insurance  departments.  Foreign  insur- 
ance companies  are  permitted  to  state  the  amount  of 
' '  surplus  to  policyholders ' '  as  shown  by  the  report  for 
the  last  fiscal  year  of  the  company.  The  only  deduction 
allowedi  by  the  Treasury  Department  is  the  amount  of 
depo.sits  actually  required  by  states  in  which  the  com- 
pany is  transacting  business.*''' 

Exemption.  As  stated  above,  an  exemption  of  $99,000 
is  allowed  from  the  capital  stock  of  each  domestic  cor- 

*6  Letter  from  Treasury  Department  dated  rebniary  10,  1917. 
47  T.  D.  2503. 


THE   CAPITAli  STOCK  TAX  553 

puiation.  lii  the  case  of  foreign  corporations  tlie  exemp- 
tion is  such  proportion  of  $99,000  as  the  amount  of 
capital  actually  invested  in  business  in  the  United  States 
bears  to  the  total  amount  invested  in  the  transaction  of 
business  within  and  without  the  United  States.  If  a 
foreign  corporation  has  all  its  capital  invested  here,  it 
will  be  entitled  to  tlie  full  amount  of  $99,000,  but  if  it 
has  only  a  fraction  of  its  capital  invested  here,  the  ex- 
emption will  be  such  fraction  of  $99,000.  This  exemp- 
tion is  allowed  only  if  the  foreign  corporation  makes  a 
return  to  the  Commissioner  of  Internal  Revenue  showing 
the  amount  of  capital  invested  in  the  transaction  of  busi- 
ness outside  the  United  States,  so  that  the  Commissioner 
of  Internal  Revenue  may  compute  the  proportion  of  the 
exemption  to  which  the  corporation  is  entitled.** 

Rate  op  Tax.  The  rate  of  tax  is  50  cents  on  each  one 
thousand  dollars  of  the  capital  actually  invested  in  the 
transaction  of  business  in  this  country,  in  excess  of  the 
amount  of  the  exemption.  If  the  capital  so  invested 
exceeds  an  amount  in  even  thousands,  the  fraction  above 
the  even  thousand  may  be  disregarded,  as  in  the  case  of 
domestic  corporations.  The  tax  is  due  at  the  same  time 
as  in  the  case  of  domestic  corporations  and  the  same 
credit  for  payment  of  munition  manufacturers'  tax  is 
extended  to  foreign  corporations.*® 

Returns.  A  return  is  required  of  every  foreign  cor- 
poration irrespective  of  the  amount  of  capital  employed 
'  ither  in  this  country  or  elsewhere  in  the  transaction  of 
its  business.*®    The  return  is  required  to  be  filed  at  thp 

*8  Act  of  September  8,  1916,  S  407. 
4»See  p.  547. 
80  T.  D.  2364. 


554  APPENDIX 

same  time  and  in  the  same  manner  as  in  the  ease  of 
domestic  corporations  and  the  same  penalties  accrue  for 
neglect  or  failure.  Returns  are  filed  with  the  local 
collector  under  the  rules  which  apply  to  the  filing  of 
returns  of  annual  net  incotne.*^  ^ 

Administration  of  the  Law.  All  Administrative  or 
special  provisions  of  the  internal  revenue  laws  including 
the  laws  relating  to  the  assessment  of  taxes,  so  far  as  ap- 
plicable, are  extended  to  and  made  a  part  of  the  section 
imposing  the  capital  stock  tax  and  every  corporation 
liable  to  the  capital  stock  tax  is  required  to  keep  such 
records  and  render,  under  oath,  such  statements  and  re- 
turns, and  comply  with  such  regulations  as  the  Commis- 
sioner of  Internal  Revenue  may  prescribe.**^ 

61  See  pp.  548  and  189. 

68  Act  of  September  8,  1916,  §  409. 


TEXT  OF  1916  LAW  AS  AMENDED' 

Title  1  or  the  Act  of  September  8,  1916,  as  Amended  by  Act 
OF  October  3, 1917. 

PAET  I.— ON  INDIVIDUALS 

Sec.  1.  (a)  That  there  shall  be  levied,  assessed,  collected,  and 
paid  auually  upon  the  entire  net  income  received  in  the  preceding" 
calendar  year  from  all  sources  by  every  individual,  a  ctizen  or 
resident  of  the  United  States,  a  tax  of  two  per  centum  upon  such 
income;  and  a  like  tax  shall  be  levied,  assessed,  collected,  and  paid 
annually  upon  the  entire  net  income  received  in  the  preceding 
calendar  year  from  all  sources  within  the  United  States  by  every 
individual,  a  non-resident  alien,  including  interest  on  bonds,  notes, 
or  other  interest- bearing  obligations  of  residents,  corporate  or 
otherwise. 

(b)  In  addition  to  the  income  tax  imposed  by  subdivision  (a) 
of  this  section  (herein  referred  to  as  the  normal  tax)  there  shall 
be  levied,  assessed,  collected,  and  paid  upon  the  total  net  income 
of  every  individual,  or,  in  the  case  of  a  non-resident  alien,  the  total 
net  income  received  from  all  sources  within  the  United  States,  an 
additional  income  tax  (herein  referred  to  as  the  additional  tax) 
of  one  per  centum  per  annum  upon  the  amount  by  which  such  total 
net  income  exceeds  $20,000  and  does  not  exceed  $40,000,  two  per 
centum  per  annum  upon  the  amount  by  which  such  total  net  in- 
come exceeds  $40,000  and  does  not  exceed  $60,000,  three  per 
centum  per  annum  upon  the  amount  by  which  such  total  net  income 
exceeds  $60,000  and  does  not  exceed  $80,000,  four  per  centum  per 
annum  upon  the  amount  by  which  such  total  net  income  exceeds 
$80,000  and  does  not  exceed  $100,000,  five  per  centum  per  annum 
upon  the  amount  by  which  such  total  net  income  exceeds  $100,000 

1  Matter  repealed  by  the  amendment  is  omitted.  New  matter  is 
shown  in  italics. 

565 


556  APPENDIX 

and  do«s  not  exceed  $150,000,  six  per  ceutuiu  per  auuum  uxjon  the 
amount  by  which  such  total  net  income  exceeds  $150,000  and  does 
not  exceed  $200,000,  seven  per  centum  per  annum  upon  the 
amount  by  which  such  total  net  income  exceeds  $200,000  and 
does  not  exceed  $250,000,  eight  per  centum  per  annum  upon  the 
amount  by  which  such  total  net  income  exceeds  $250,000  and  does 
not  exceed  $300,000,  nine  per  centum  per  annum  upon  the  amount 
by  which  such  total  net  income  exceeds  $300,000  and  does  not 
exceed  $500,000,  ten  per  centum  per  annum  upon  the  amount  by 
which  sucli  total  net  income  exceeds  $500,000  and  does  not  exceed 
$1,000,000,  eleven  per  centuni  per  annum  upon  the  amount  by 
which  such  total  net  income  exceeds  $1,000,000  and  does  not  exceed 
$1,500,000,  twelve  per  centum  per  annum  upon  the  amount  by 
which  such  total  net  income  exceeds  $1,500,000  and  does  not  exceed 
$2,000,000,  and  thirteen  per  centum  per  annum  upon  the  amount 
by  which  such  total  net  income  exceeds  $2,000,000. 

For  the  purpose  of  the  additional  tax  there  shall  be  included  as 
income  the  income  derived  from  dividends  on  the  capital  stock  or 
from  the  net  earnings  of  any  corporation,  joint-stock  company  or 
association,  or  insurance  compuny,  except  that  in  the  case  of  non- 
resident aliens  such  income  derived  from  sources  without  the 
Tnited  States  shall  not  be  included. 

All  the  provisions  of  this  title  relating  to  the  normal  tax  on 
individuals,  so  far  as  they  are  applicable  and  are  not  inconsistent 
with  this  subdivision  and  section  three,  shall  apply  to  the  imposi- 
tion, levy,  assessment,  and  collection  of  the  additional  tax  im- 
posed under  this  subdivision. 

(c)     The  foregoing  normal  and  additional  tax  rates  shall  app^!; 
to  the  entire  net  income,  except  as  hereinafter  provided,  receiveH' 
by  every  taxable  person  in  the  calendar  year  nineteen  hundred  and 
sixteen  and  in  each  calendar  year  thereafter. 

INCOME  DEFINED 

Sec.  2.  (a)  That,  subject  only  to  such  exemptions  and  deduc- 
tions as  are  hereinafter  allowed,  the  net  income  of  a  taxable  person 
shal  include  gains,  profits,  and  income  derived  from  salaries,  wages, 
or  compensation  for  personal  service  of  whatever  kind  and  in 
whatever  form  paid,  or  from  professions,  vocations,  businesses, 
trade,  commerce,  or  sales,  or  dealings  in  property,  whether  real 
or  personal,  growing  out  of  the  ownership  or  use  of  or  interest 


TEXT   OF  1916    L>AW   AS  AMENDED  557 

ill  real  or  personal  property,  also  from  interest,  rent,  dividends, 
securities,  or  the  transaction  of  any  business  carried  on  for  gain 
or  profit,  or  gains  or  profits  and  income  derived  from  any  source 
whatever. 

(b)  Income  received  by  estates  of  deceased  persons  during  the 
period  of  admimstratiou  or  settlement  of  the  estate,  shall  be  sul)- 
ject  to  the  nornuil  and  additional  tax  and  taxed  to  their  estates, 
and  also  sueii  ineonic  of  estates  or  any  kind  of  property  hrid  in 
trust,  including  such  income  accumulated  in  trust  for  the  benefit 
of  unborn  or  unascertained  persons,  or  persons  with  contingent 
interests  an<l  income  held  for  future  distribution  under  the  terms 
of  the  will  or  trust  shall  be  likewise  taxed,  the  tax  in  each  instance,  - 
except  where  the  income  is  returned  for  the  pur|>08e  of  the  tax 
by  the  beneficiary,  to  be  assessed  to  the  executor,  administrator, 
or  trustee,  as  the  case  may  be :  Provided,  That  where  -the  income 
is  to  be  distributed  annually  or  regularly  between  existing  heirs 
or  legatees,  or  beneficiaries  the  rate  of  tax  and  metliod  of  coin- 
]>uting  the  same  shall  be  based  in  each  case  upon  the  amount  of 
the  individual  share  to  be  distributed. 

Such  trustees,  executors,  administrators,  and  other  fiduciaries 
are  hereby  indemnified  against  the  claims  or  demands  of  every 
beneficiary  for  all  payments  of  taxes  which  they  shall  be  required 
to  make  under  the  provisions  of  this  title,  and  they  shall  have 
credit  for  the  amount  of  such  payments  against  tlie  beneficiary 
or  principal  in  any  accounting  which  they  make  as  such  trustees 
or  other  fiduciaries. 

(c)  For  the  purpose  of  ascertaining  the  gain  derived  froiu  the 
sale  or  other  disposition  of  property,  real,  jjcrsonal,  or  mixed, 
acquired  before  March  first,  nineteen  hundred  and  thirteen,  the 
fair  market  price  or  value  of  such  property  as  of  March  first, 
nineteen  hundred  and  thirteen,  shall  be  the  basis  for  determining 
the  amount  of  such  gain  derived. 

ADDITIONAL    TAX    INCLUDES    UNDISTRIBUTED 
PROFITS 

Sec.  3.  For  the  purpose  of  the  additional  tax,  the  'taxable 
income  of  any  individual  shall  include  the  share  to  which  he  would 
be  entitled  of  the  gains  and  profits,  if  divided  or  distributed, 
whether  divided  or  distributed  or  not,  of  all  corporations,  joint- 
stock  companies  or  associations,  or  insurance  companies,  however 


558  APPENDIX 

created  or  orgaiiized,  formed  or  fraudulently  availed  of  for  the 
purpose  of  preventing  the  imposition  of  such  tax  through  the 
medium  of  permitting  such  gains  and  profits  to  accumulate 
instead  of  being  divided  or  distributed;  and  the  fact  that  any 
such  corporation,  joint-stock  company  or  association,  or  insurance 
company,  is  a  mere  holding  company,  or  that  the  gains  and  profits 
are  permitted  to  accumulate  beyond  the  reasonable  needs  of  the 
business,  shall  be  prima  facie  evidence  of  a  fraudulent  purpose 
to  escape  such  tax;  but  the  fact  that  the  gains  and  profits  are  in 
any  ease  permitted  to  accumulate  and  become  surplus  shaU  not  be 
construed  as  evidence  of  a  purpose  to  escape  the  said  tax  in  such 
case  unless  the  Secretary  of  the  Treasury  shall  certify  that  in  his 
opinion  such  accumulation  is  unreasonable  for  the  purposes  of  the 
business.  When  requested  by  the  Commissioner  of  Internal  Kevenue, 
or  any  district  collector  of  internal  revenue,  such  corporation,  joint- 
stock  company  or  association,  or  insurance  company  shall  forward 
to  him  a  correct  statement  of  such  gains  and  profits  and  the 
names  and  addresses  of  the  individuals  or  shareholders  who  would 
be  entitled  to  the  same  if  divided  or  distributed. 

INCOME   EXEMPT   FROM  LAW 

Sec.  4.  The  following  income  shall  be  exempt  from  the  pro- 
visions of  this  title: 

The  proceeds  of  life  insurance  policies  paid  to  individual 
beneficiaries  upon  the  death  of  the  insured;  the  amount  received 
by  the  insured,  as  a  return  of  premium  or  premiums  paid  by  him 
under  life  insurance,  endowment,  or  annuity  contracts,  either 
during  the  term  or  at  the  maturity  of  the  term  mentioned  in  the 
contract  or  upon  the  surrender  of  the  contract;  the  value  of 
property  acquired  by  gift,  bequest,  devise,  or  descent  (but  the 
income  from  such  property  shall  be  included  as  income) ;  interest 
upon  the  obligations  of  a  State  or  any  political  subdivision  thereof 
or  upon  the  obligations  of  the  United  States  {hut,  in  the  case  of 
obligations  of  the  United  States  issued  aftei-  September  first, 
nineteen  hundred  and  seventeen,  only  if  and  to  the  extent  provided 
in  the  Act  authorizing  the  issue  thereof)  or  its  possessions  or 
securities  issued  under  the  provisions  of  the  Federal  Farm  Loan 
Act  of  July  seventeenth,  nineteen  hundred  and  sixteen;  the  com- 
pensation of  the  present  President  of  the  United  States  during 
the  term  for  which  he  has  been  elected,  and  the  judges  of  the 


TEXT   OF  1916    LAW   A8   AMENDED  559 

Supreme  and  inferior  courts  of  the  United  States  now  in  office, 
and  the  compensation  of  all  officers  and  employees  of  a  State, 
or  any  political  subdivision  thereof,  except  when  such  compensa- 
tion is  paid  by  the  United  States  Government. 

DEDUCTIONS  ALLOWED 

Sec.  5.  That  in  computing  net  income  in  the  case  of  a  citizen 
or  resident  of  the  United  States — 

(o)  For  the  purpose  of  the  tax  there  shall  be  allowed  as 
deductions — 

First.  The  necessary  expenses  actually  paid  in  carrying  on 
any  business  or  trade,  not  including  personal,  living,  or  family 
expenses ; 

Second.  All  interest  paid  within  the  year  on  his  indebtedness 
except  on  indebtedness  incurred  for  the  purchase  of  obligations  or 
securities  the  interest  upon  which  is  exempt  from  taxation  as 
income  under  this  title; 

Third.  Taxes  paid  within  the  year  imposed  by  the  authority 
of  the  United  States  (except  income  and  excess  profits  taxes)  or  of 
its  Territories,  or  possessions,  or  any  foreign  country,  or  by  the 
authority  of  any  State,  county,  school  district,  or  municipality, 
or  other  taxing  subdivision  of  any  State,  not  including  those 
assessed  against  local  benefits; 

Fourth.  Losses  actually  sustained  during  the  year,  incurred 
in  his  business  or  trade,  or  arising  from  fires,  storms,  shipwreck, 
or  other  casualty,  and  from  theft,  when  such  losses  are  not  com- 
pensated for  by  insurance  or  otherwise:  Provided,  That  for  the 
puri)Ose  of  ascertaining  the  loss  sustained  from  the  sale  or  other 
disposition  of  property,  real,  personal,  or  mixed,  acquired  before 
March  first,  nineteen  hundred  and  thirteen,  the  fair  market  price  or 
value  of  such  property  as  of  March  first,  nineteen  hundred  and 
thirteen,  shall  be  the  basis  for  determining  the  amount  of  such 
loss  sustained; 

Fifth.  In  transactions  entered  into  for  profit  but  not  con- 
nected with  his  business  or  trade,  the  losses  actually  sustained 
therein  during  the  year  to  an  amount  not  exceeding  the  profits 
arising  therefrom; 

Sixth.  Debts  due  to  the  taxpayer  actually  ascertained  to  be 
worthless  and  charged  off  within  the  year; 

Seventh.     \  reasonable  allowance  for  the  exhaustion,  wear  and 


5^0,  APPENDIX 

tear  of  property  arising  out  of  its  use  or  employnieut  in  the  busi- 
ness or  trade; 

Eiglith.  (a)  In  the  case  of  oil  and  gas  wells  a  reasonable 
allowance  for  actual  reduction  in  flow  and  production  to  be  ascer- 
tained not  by  the  flush  flow,  but  by  the  settled  production  or 
regular  flow;  (b)  in  the  ease  of  mines  a  reasonable  allowance 
for  depletion  thereof  not  to  exceed  the  market  value  in  the 
mine  of  the  product  thereof,  which  has  been  mined  and  sold  dur- 
ing the  year  for  which  the  return  and  computation  are  made, 
such  reasonable  allowance  to  be  made  in  the  case  of  both  (a) 
and  (b)  under  rules  and  regulations  to  be  prescribed  by  the 
Secretary  of  the  Treasury:  Provided,  That  when  the  allowances 
authorized  in  (a)  and  (b)  shall  equal  the  capital  originally 
invested,  or  in  case  of  purchase  made  prior  to  March  1,  1913, 
the  fair  market  value  as  of  that  date,  no  further  allowance  shall 
be  made.  No  deductions  shall  be  allowed  for  any  amount  paid 
out  for  new  buildings,  permanent  improvements,  or  betterments, 
made  to  increase  the  value  of  any  property  or  estate,  and  no  deduc- 
tion shall  be  made  for  any  amount  of  expense  of  restoring 
property  or  making  good  the  exhaustion  thereof  for  which  an 
allowance  is  or  has  been  made; 

Ninih.  ContHhutions  or  gifts  actxmlly  made  within  the  year 
to  corporations  or  assooiati<ms  organized  and  operated  exclusivehj 
for  religious, .  charitable,  scientific,  or  educational  purposes,  or  to 
societies  fot  the  prevention  of  cruelty  to  children  oi-  animals,  no 
part  of  the  net  income  of  which  inures  to  the  benefit  of  any  private 
stocJcJiolder  or  individual,  to  an  amount  not  i7i  excess  of  fifteen 
per  centum,  of  tJie  taxpayer's  taxable  net  income  a^  computed 
vAthout'  the  benefit  of  this  paragraph.  Such  contributions  or 
gifts  shall  be  allowable  as  deductions  only  if  verified  under  rules 
and  regulations  prescribed  by  the  Commissioner  of  Interiuil  Eeve- 
nue,  with  tlie  approval  of  the  Seci-eiary  of  the  Treasury. 

CREDITS   ALLOWED 

(&)  For  the  purpose  of  the  normal  tax  only,  the  income 
embraced  in  a  personal  return  shall  be  credited  with  the  amount 
received  as  dividends  upon  the  stock  or  from  the  net  earnings  of 
any  corporation,  joint-stock  company  or  association,  trustee  or 
insurance  company,  wliich  is  taxable  upon  its  net  income  as  herein- 
after provided; 


TEXT   OK  1916    LAW    AS   AMENDED  561 

( (  )  A  like  credit  shall  be  allowed  as  to  the  amount  of  iiicouio, 
tlio  iiurtnal  tax  upon  which  Iiuh  been  paid  or  withheld  for  payment 
ut  the  boiirce  of  the  income  under  the  provisions  of  this  title. 

NON-RESIDENT  ALIENS 

Sec.  6.  That  in  computing  net  income  in  the  case  of  a  non- 
resident alien — 

(a)  For  the  purpose  of  the  tax  there  shall  be  allowed  as 
deductions — 

First.  The  necessary  expenses  actually  paid  in  carrying  on 
any  business  or  trade  conducted  by  him  within  the  United  States, 
not  including  personal,  living,  or  family  expenses; 

Second.  The  proportion  of  all  interest  paid  within  the  year 
by  such  person  on  his  indebtedness  (except  on  iitdebtedness  in- 
curred far  the  purcJiase  of  obligations  or  securities  the  interest 
upon  which  is  exempt  fram  taxation  as  income  under  this  title) 
which  the  gross  amount  of  his  income  for  the  year  derived  from 
sources  within  the  United  States  bears  to  the  gross  amount  of  his 
income  for  the  year  derived  from  all  sources  within  and  without 
the  United  States,  but  this  deduction  shall  be  allowed  only  if 
such  person  includes  in  the  return  required  by  section  eight  all 
the  information  necessary  for  its  calculation; 

Third.  Taxes  paid  within  the  year  imposed  by  the  authority 
of  the  United  States  (except  income  and  excess  profits  taxes), 
or  of  its  Territories,  or  jjossessions,  or  by  the  authority  of  any 
State,  county,  school  district,  or  municipality,  or  other  taxing 
subdivision  of  any  State,  paid  within  the  United  States,  not 
including  those  assessed  against  local  benefits; 

Fourth.  Losses  actually  sustained  during  the  year,  incurre«l 
in  business  or  trade  conducted  by  him  within  the  United  States, 
and  losses  of  property  within  the  United  States  arising  from 
fires,  storms,  shipwreck,  or  other  casualty,  and  from  theft,  when 
such  losses  are  not  comj^nsated  for  by  insurance  or  otherwise: 
Provided,  That  for  tlie  purpose  of  ascertaining  the  amount  of 
such  loss  or  losses  sustained  in  trade,  or  speculative  transactions 
not  in  trade,  from  the  same  or  any  kind  of  jiroperty  acquireil 
before  March  first,  nineteen  hundred  and  thirteen,  the  fair  market 
price  or  value  of  such  property  as  of  March  first,  nineteen  hundreil 
and  thirteen,  shall  be  the  basis  for  determining  the  amount  of 
such  loss  or  losses  sustained; 
P.  T.  Tax.— 36 


562  APPENDIX 

Fifth.  In  transactions  entered  into  for  profit  but  not  con- 
nected with  his  business  or  trade,  the  Ipsses  actually  sustained 
therein  during  the  year  to  an  amount  not  exceeding  the  profit 
arising  therefrom  in  the  United  States; 

Sixth.  Debts  arising  in  the  course  of  business  or  trade  con- 
ducted by  him  within  the  United  States  due  to  the  taxpayer  actu- 
ally ascertained  to  be  worthless  and  charged  off  within  the  year; 

Seventh.  A  reasonable  allowance  for  the  exhaustion,  wear  and 
tear  of  property  within  the  United  States  arising  out  of  its  use 
or  employment  in  the  business  or  trade;  (a)  in  the  case  of  oil 
and  gas  wells  a  reasonable  allowance  for  actual  reduction  iit 
flow  and  production  to  be  ascertained  not  by  the  flush  flow,  but 
by  the  settled  production  or  regular  flow;  (b)  in  the  case  of 
mines  a  reasonable  allowance  for  depletion  thereof  not  to  exceed 
the  market  value  in  the  mine  of  the  product  thereof  which  has 
been  mined  and  sold  during  the  year  for  which  the  return  and 
computation  are  made,  such  reasonable  allowance  to  be  made 
in  the  case  of  both  (a)  and  (b)  under  rules  and  regulations  to 
be  prescribed  by  the  Secretary  of  the  Treasury:  Provided,  That 
when  the  allowance  authorized  in  (a)  and  (b)  shall  equal  the 
capital  originally  invested,  or  in  case  of  purchase  made  prior  to 
March  first,  nineteen  hundred  and  thirteen,  the  fair  market  value 
as  of  that  date,  no  further  allowance  shall  be  made.  No  deduction 
shall  be  allowed  for  any  amount  paid  out  for  new  buildings, 
permanent  improvements,  or  betterments,  made  to  increase  the 
value  of  any  property  or  estate,  and  no  deduction  shall  be  made 
for  any  amount  of  expense  of  restoring  property  or  making  good 
the  exhaustion  thereof  for  which  an  allowance  is  or  has  been 
made. 

(6)  There  shall  also  be  allowed  the  credits  specified  by  sub- 
divisions (&)  and  (c)  of  section  five. 

(c)  A  nan-resident  alien  individual  sJuill  receive  the  benefit 
of  t%e  dedxictions  and  credits  provided  for  in  this  section  only  by 
filing  or  causing  to  be  filed  with  the  collector  of  internal  revenue 
a  true  and  accurate  return  of  his  total  income,  received  from  all 
sources,  corporate  or  otherwise,  in  the  United  States,  in  the  man- 
ner prescribed  by  this  title;  and  in  case  of  his  failure  to  file  sru'h 
return  the  collector  shall  collect  the  tax  on  such  income,  and  all 
property  belonging  to  such  non-resident  alien  individual  shall  be 
liable  to  distraint  for  the  tax. 


TEXT   OF   1916    LAW   AS   AMENDliU)  563 

PERSONAL    EXEMPTION 

Sec.  7.  That  for  the  purpose  of  the  normal  tax  only,  there  shall 
be  allowed  as  an  exemption  in  the  naturq  of  a  deduction  from  the 
amount  of  net  income  of  each  citizen  or  resident  of  the  United  States, 
ascertained  as  provided  herein,  the  sum  of  $3,000,  plus  $1,000  addi- 
tional if  the  person  making  the  return  be  a  head  of  a  family 
or  a  married  man  with  a  wife  living  with  him,  or  plus  the  sum  of 
!fl,000  additional  if  the  person  making  the  return  be  a  mairied 
woman  with  a  husband  living  with  her;  but  in  no  event  shall  tnis 
additional  exemption  of  $1,000  be  deducted  by  both  a  husband 
and  a  wife:  Provided,  That  only  one  deduction  of  $4,000  shall 
he  made  from  the  aggregate  income  of  both  husband  and  wife 
when  living  together:  Provided  further,  That  if  the  person  mak- 
ing the  return  is  the  head  of  a  family  there  shall  be  an  additional 
exemption  of  $200  for  each  child  dependent  upon  such  person, 
if  under  eighteen  years  of  age,  or  if  incapable  of  self-support 
because  mentally  or  physically  defective,  but  this  provision  shall 
operate  only  in  the  case  of  one  parent  in  the  same  family:  Pro- 
vided further.  That  guardians  or  trustees  shall  be  allowed  to 
make  this  personal  exemption  as  to  income  derived  from  the 
property  of  which  such  guardian  or  trustee  has  charge  in  favor  of 
each  ward  or  cestui  que  trust:  Provided  further.  That  in  no 
event  shall  a  ward  or  cestui  que  trust  be  allowed  a  greater  per- 
sonal exemption  than  as  provided  in  this  section,  from  the  amount 
of  net  income  received  from  all  sources.  There  shall  also  be 
allowed  an  exemption  from  the  amount  of  the  net  income  of 
estates  of  deceased  citizens  or  residents  of  the  United  States 
during  the  period  of  administration  or  settlement,  and  of  trust 
or  other  estates  of  citizens  or  residents  of  the  United  States  the 
income  of  which  is  not  distributed  annually  or  regularly  under 
the  provisions  of  subdivision  (b)  of  sect'on  two,  the  sum  of  $3,000, 
including  such  deductions  as  are  allowed  under  section  five. 

Sec.  8.  (a)  The  tax  shall  be  computed  upon  the  net  income, 
as  thus  ascertained,  of  each  person  subject  thereto,  received  in 
each  preceding  calendar  year  ending  December  thirty-first. 

(b)  On  or  before  the  first  day  of  March,  nineteen  hundred 
and  seventeen,  and  the  first  day  of  March  in  each  year  thereafter, 
a  true  and  accurate  return  under  oath  shall  be  made  by  each  per- 
son of  lawful  age,  except  aa  hereinafter  provided,  having  a  net 
income  of  $3,000  or  over  for  the  taxable  year  to  the  collector 


564  APPENDIX 

of  intcnial  revenue  for  the  district  iu  which  such  person  has 
his  legal  residence  or  principal  place  of  business,  or  if  there  be 
no  legal  residence  or  place  of  business  in  the  United  States,  then 
with  the  collector  of  internal  revenue  at  Baltimore,  Maryland, 
in  such  form  as  the  Commissioner  of  Internal  Revenue,  with  the 
approval  of  the  Secretary  of  the  Treasury,  shall  prescrilfe,  set- 
ting forth  specifically  the  gross  amount  of  income  from  all  sep- 
arate sources,  and  from  the  total  thereof  deducting  the  aggre- 
gate items  of  allowances  herein  authorized:  Pro\aded,  That  the 
Commissioner  of  Internal  Revenue  shall  have  authority  to  grant 
a  reasonable  extension  of  time,  in  meritorious  cases,  for  filing 
returns  of  income  by  persons  residing  or  traveling  abroad  who  are 
required  to  make  and  file  returns  of  income  and  who  are  unable 
to  file  said  returns  on  or  before  March  first  of  each  year:  Pro- 
vided further,  That  the  aforesaid  return  may  be  made  by  an 
agent  when  by  reason  of  illness,  absence,  or  non-residence  the 
person  liable  for  said  return  is  unable  to  make  and  render  the 
same,  the  agent  assuming  the  responsibility  of  making  the  return 
and  incurring  penalties  provided  for  erroneous,  false,  or  fraudulent 
return. 

(c)  Guardians,  trustees,  executors,  administrators,  receivers, 
conservators,  and  all  persons,  corporations,  or  associations,  acting 
in  any  fiduciary  capacity,  shall  make  and  render  a  return  of  the 
income  of  the  person,  trust,  or  estate  for  whom  or  which  they  act, 
and  be  subject  to  aU  the  provisions  of  this  title  which  apply  to 
individuals.  Such  fiduciary  shall  make  oath  that  he  has  sufii- 
cient  knowledge  of  the  affairs  of  such"  person,  trust,  or  estate 
to  enable  him  to  make  such  return  and  that  the  same  is,  to  the 
best  of  his  knowledge  and  belief,  true  and  correct,  and  be  subject 
to  .all  the  provisions  of  this  title  which  apply  to  individuals: 
Provided,  That  a  return  made  by  one  of  two  or  more  joint  fidu- 
ciaries filed  in  the  district  where  such  fiduciary  resides,  under 
such  regulations  as  the  Secretary  of  the  Treasury  may  prescribe, 
shall  be  a  sufficient  compliance  with  the  requirements  of  this 
paragraph:  Provided  further,  That  no  return  of  income  not  ex- 
ceeding $3,000  shall  he  required  except  as  in  this  title  otherwise 
provided. 

[Subdivision  (d)  repealed.  This  subdivision  related  to  with- 
holding the  tax  at  the  source.] 

(e)  Persons  carrying  on  business  in  partnership  shall  be  liable 
for  income   tax  only   in  their   individual  capacity,  and  the  share 


TEXT   OF  1016    LAW  AS  AMENDED  565 

uf  tiie  profits  of  the  partnership  to  which  any  taxable  partner 
would  be  entitled  if  the  same  were  divided,  whether  divided  or 
otherwise,  shall  be  returned  for  taxation  and  the  tax  paid  under 
the  provisions  of  this  title:  Provided,  Tliat  from  the  net  dis- 
tributive interests  on  which  the  individual  members  shall  be 
liable  for  tax,  normal  and  additional,  there  shall  be  excluded 
their  j)roportionate  shares  received  from  interest  on  the  obliga- 
tions of  a  State  or  any  political  or  taxing  subdivision  thereof, 
and  upon  the  obligations  of  the  United  States  {if  and  to  the 
extent  that  it  is  provided  in  the  Act  authorising  the  issue  of  such 
obligations  of  tfic  United  States  that  they  are  exempt  from  taxa- 
tion) and  its  possessions,  and  that  for  the  purpose  of  computing 
the  normal  tax  there  shall  be  allowed  a  credit,  as  provided  by 
section  five,  subdivision  (6),  for  their  proportionate  share  of  the 
profits  derived  from  dividends.  Such  partnership,  when  re- 
quested by  the  CJommissioner  of  Internal  Revenue,  or  any  dis- 
trict collector,  sliall  render  a  correct  return  of  the  earnings,  profits, 
and  income  of  the  partnership,  except  income  exempt  under  sec- 
tion four  of  this  Act,  setting  forth  the  item  of  the  gross  income 
and  the  deductions  and  credits  allowed  by  this  title,  and  the 
names  and  addresses  of  the  individuals  who  would  be  entitled  to 
the  net  earnings,  profits,  and  income,  if  distributed.  A  partner- 
ship shall  have  iJu;  same  privilege  of  fixitig  and  making  returns 
upon  the  basis  of  its  own  fiscal  year  as  is  accorded  to  corporations 
under  this  title.  If  a  fiscal  year  ends  during  nineteen  hundred 
and  sixteen  or  a  subsequent  calendar  year  for  which  there  is  a 
rate  of  tax  different  from  the  rate  for  the  preceding  calendar  year, 
then  (1)  the  rate  for  such  preceding  calendar  year  sluUl  apply  to 
an  amount  of  each  partner's  share  of  such  partnership  profits 
equal  to  the  proportion  which  the  part  of  such  fiscal  year  falling 
within  such  calendar  year  bears  to  the  full  fiscal  year,  and  (2) 
the  rate  for  the  calendar  year  during  which  such  fiscal  year  ends 
sheUl  apply  to  the  remainder. 

(/)  In  every  return  shall  be  included  the  income  derived  from 
dividends  on  the  capital  stock  or  from  the  net  earnings  of  any 
corporation,  joint-stock  company  or  association,  or  insurance  com- 
pany, except  that  in  the  case  of  non-resident  aliens  such  income 
derived  from  sources  without  the  United  States  shall  not  be  in- 
cluded. 

(<7)  An  individual  keeping  accounts  upon  any  basis  other  than 
that  of  a<'tiial  receipts  and  disbursements,  unless  such  other  Imisis 


566  APPENDIX 

does  not  clearly  reflect  his  income,  may,  subject  to  regulations 
made  by  the  Commissioner  of  Internal  Eevenue,  with  the  approval 
of  the  Secretary  of  the  Treasury,  make  his  return  upon  tlie  basis 
upon  which  his  accounts  are  kept,  ta  which  case  the  tax  shall  be 
computed  upon  his  income  as  so  returned. 

ASSESSMENT  AND  ADMINISTRATION 

Sec.  9.  (a)  That  all  assessments  shall  be  made  by  the  Com- 
missioner of  Internal  Revenue  and  all  persons  shall  be  notified  of 
the  amount  for  which  they  are  respectively  liable  on  or  belore  the 
first  day  of  June  of  each  successive  year,  and  said  amounts  shall 
be  paid  on  or  before  the  fifteenth  day  of  June,  except  in  cases  of 
refusal  or  neglect  to  make  such  return  and  in  cases  of  erroneous, 
false,  or  fraudulent  returns,  in  which  cases  the  Commissioner  of 
Internal  Revenue  shall,  upon  the  discovery  thereof,  at  any  time 
within  three  years  after  said  return  is  due,  or  has  been  made, 
make  a  return  upon  information  obtained  as  provided  for  in  this 
title  or  by  existing  law,  or  require  the  necessary  corrections  to 
be  made,  and  the  assessment  made  by  the  Commissioner  of  Inter- 
nal Revenue  thereon  shall  be  paid  by  such  person  or  persons  imme- 
diately upon  notification  of  the  amount  of  such  assessment;  and 
to  any  sum  or  sums  due  and  unpaid  after  the  fifteenth  day  of 
June  in  any  year,  and  for  ten  days  alter  notice  and  demand  tuereof 
by  the  collector,  there  shall  be  added  the  sum  of  five  per  centum 
on  the  amount  of  tax  unpaid,  and  interest  at  the  rate  of  one  per 
centum  per  month  upon  said  tax  from  the  time  the  same  became  due, 
except  from  the  estates  of  insane,  deceased,  or  insolvent  persons. 

(fc)  All  persons,  corporations,  partnerships,  associat.ons,  and 
insurance  companies,  in  whatever  capacity  acting,  including  lessees 
or  mortgagors  of  real  or  personal  property,  trustees  acting  in 
any  trust  capacity,  executors,  administrators,  receivers,  conserva- 
tors, employers,  and  all  officers  and  employees  of  the  United 
States,  having  the  control,  receipt,  custody,  disposal,  or  payment 
of  interest,  rent,  salaries,  wages,  premiums,  annuities,  compensa- 
tion, remuneration,  emoluments,  or  other  fixed  or  determinable 
annual  or  periodical  gains,  profits,  and  income  of  a7iy  non-resi- 
dent alien  individual,  other  than  income  derived  from  dividends 
on  capital  stock,  or  from  the  net  earnings  of  a  corpmation,  joint- 
stock  company  or  association,  or  insurance  company,  which  is  tax- 
able upon  its  net  income  as  provided  in  this  title,  are  hereby 


TEXT   OF  1916    LAW   AS  AMENDED 


'567 


authorized  and  required  to  deduct  and  withhold  from  such  annual 
or  periodical  gains,  profits,  and  income,  such  sum  as  will  be  suffi- 
cient to  pay  the  normal  tax  imposed  thereon  by  this  title,  and 
shall  make  return  thereof  an  or  before  March  first  of  each  year 
and,  on  or  before  the  time  fixed  by  law  for  the  payment  of  the 
tax,  shall  pay  the  amount  withheld  to  the  officer  of  the  United 
States  Government  authorized  to  receive  the  same;  and  they  are 
each  hereby  made  personally  liable  for  such  tax,  and  they 
are  each  hereby  indemnified  against  every  person,  corporation, 
partnership,  association,  or  insurance  company,  or  demand  what- 
soever for  all  payments  which  they  shall  make  in  pursuance  and 
by  virtue  of  this  title. 

(c)  The  amount  of  the  normal  tax  hereinbefore  imposed  shall 
also  be  deducted  and  vnthheld  from  fixed  or  determinable  an- 
nual or  periodical  gains,  profits,  and  income  derived  from  inter- 
est upon  bonds  and  mortgages,  or  deeds  of  trust  or  other  similar 
obligations  of  corporations,  joint-stock  companies,  associations, 
and  insurance  companies,  (if  such  bonds,  mortgages,  or  other 
obligations  contain  a  contract  or  provision  by  which  the  obligor 
agrees  to  pay  any  portion  of  the  tax  imposed  by  this  title  upon 
the  obligee  or  to  reimburse  the  obligee  for  any  portioti  of  the  tax 
or  to  pay  the  interest  without  deduction  for  any  tax  which  the 
obligor  may  be  required  or  permitted  to  pay  thereon  or  to  retain 
therefrom  under  any  law  of  the  United  States),  whether  payable 
annually  or  at  shorter  or  longer  periods,  and  whether  such  interest 
is  payable  to  a  nonresident  alien  individual  or  to  an  individual 
citizen  or  resident  of  the  United  SJtates,  subject  to  the  provisions 
of  the  foregoing  subdivision  (6)  of  this  section  requiring  the 
tax  to  be  withheld  at  the  source  and  deducted  from  annu^  income 
and  returned  and  paid  to  tlie  Government,  unless  the  person  entitled 
to  receive  »ucfc  interest  shall  file  with  the  withholding  agent  on  or 
before  February  first,  a  signed  notice  in  writing  claiming  the 
benefit  of  an  exemption  under  section  seven  of  this  title. 

[Subdivisions  (d)  and  (e)  relating  to  withholding  at  the  source 
were  repealed.] 

(/)  All  persons,  corporations,  partnerships,  or  associations, 
undertaking  as  a  matter  of  business  or  for  profit  the  collection  of 
foreign  payments  of  interest  or  dividends  by  means  of  coupons, 
checks,  or  bills  of  exchange  shall  obtain  a  license  from  the  Com- 
missioner of  Internal  Revenue,  and  shall  be  subject  to  such  regu- 
lations enabling  the  Government  to  obtain  the  information   re- 


568  APPENDIX 

qmred  under  this  title,  as  the  Commissioner  of  Internal  Eevenue, 
with  the  approval  of  the  Secretary  of  the  Treasury,  shall  pre- 
scribe; and  whoever  knowingly  undertakes  to  collect  sueli  pay- 
ments as  aforesaid  without  having  obtained  a  license  therefor, 
or  without  complying  with  sucli  regulations,  shall  be  deemed 
guilty  of  a  misdemeanor  and  for  each  offense  be  fined  in  a  sum 
not  exceeding  $5,000,  or  imprisoned  for  a  term  not  exceeding  one 
year,  or  both,  in  tlie  discretion  of  the  court. 

(g)  The  tax  herein  imposed  upon  gains,  profits,  and  incomes 
not  falling  under  the  foregoing  and  not  returned  and  paid  by 
virtue  of  the  foregoing  or  as  otherwise  provided  l)y  law  shall  be 
assessed  by  personal  return  under  rules  and  regulations  to  be 
prescribed  by  the  Commissioner  of  Internal  Eevenue  and  approved 
by  the  Secretary  of  the  Treasury.  The  intent  and  purpose  of 
this  title  is  that  all  gains,  profits,  and  income  of  a  taxable  class, 
as  defined  by  this  title,  shall  be  charged  and  assessed  with  the 
corresponding  tax,  normal  and  additional,  prescribed  by  this  title, 
and  said  tax  shall  be  paid  by  the  owner  of  such  income,  or  the 
]>roper  representative  having  the  receipt,  custody,  control,  or  dis- 
])Osal  of  the  same.  For  the  purpose  of  this  title  ownership  or  lia- 
bility shall  be  determined  as  of  the  year  for  which  a  return  is 
required  to  be  rendered. 

The  provisions  of  this  section  except  subdivision  (c),  relating 
to  the  deduction  and  payment  of  the  tax  at  the  source  of  income 
shall  only  apply  to  the  normal  tax  hereinbefore  imposed  upon 
non-resident  alien  individuals. 

PART    H.-ON    CORPORATIONS 

Sec.  10.  (a)  That  there  shall  be  levied,  assessed,  collecte<1 
and  paid  annually  upon  the  total  net  income  received  in  the  pre- 
ceding calendar  year  from  all  sources  by  every  corporation,  joint- 
stock  company  or  association,  or  insurance  company,  organized 
in  the  United  States,  no  matter  how  created  or  organized  but  not 
including  partnerships,  a  tax  of  two  per  centum  upon  such  income; 
and  a  like  tax  shall  be  levied,  assessed,  collected,  and  paid  annually 
upon  the  total  net  income  received  in  the  preceding  calendar  year 
from  all  sources  within  the  United  States  by  every  corporation,^ 
jomt-stock  company  or  association,  or  insurance  company,  organ- 
ized, authorized,  or  existing  under  the  laws  of  any  foreign  country, 
including  interest  on  bonds,  notes,  or  other  interest-bearing  obli- 


TEXT   <tK   1916    LAW   AS  AMENDED  569 

;;;il.ioiis  of  residents,  corporate  or  otherwise,  and  including  the 
iitcoiiiu  derived  from  dividends  on  capital  stock  or  from  not  earn- 
ings of  resident  corporations,  joint-stock  companies  or  associations, 
or  insurance  companies,  whose  net  incomo  is  taxable  under  this 
title. 

The  foregoing  tax  rate  shall  apply  to  the  total  net  income 
received  by  every  taxable  corporation,  joint-stock  company,  or 
association,  or  insurance  company  in  the  calendar  year  nineteen 
hundred  and  sixteen  and  in  each  year  thereafter,  except  that  if 
it  has  fixed  its  own  fiscal  year  under  the  provisions  of  existing 
law,  the  foregoing  rate  shall  apply  to  the  proportion  of  the  total 
net  income  returned  for  the  fiscal  year  ending  prior  to  December 
thirty -first,  nineteen  hundred  and  sixteen,  which  the  period  between 
.January  first,  nineteen  hundred  and  sixteen,  and  the  end  of  sucli 
fiscal  year  bears  to  the  whole  of  such  fiscal  year,  and  the  rate 
fixed  in  Section  II  of  the  Act  approved  October  third,  nineteen 
liundred  and  thirteen,  entitled  "An  Act  to  reduce  tariff  duties 
and  to  provide  revenue  for  the  Government,  and  for  other  pur- 
poses. ' '  shall  apply  to  the  remaining  i>ortion  of  the  total  net 
income  returned  for  such  fiscal  year. 

For  the  purpose  of  ascertaining  the  gain  derived  or  loss  sus- 
tained, from  the  sale  or  other  disposition  by  a  corporation,  joint- 
stock  company,  or  association,  or  insurance  company,  of  jiroperty, 
real,  personal,  or  mixed,  acquired  before  March  first,  nineteen 
hundred  and  thirteen,  the  fair  market  price  or  value  of  such 
jiroperty  as  of  March  first,  nineteen  hundred  and  thirteen,  shall 
be  the  basis  for  determining  the  amount  of  such  gain  derived  or 
loss  sustained. 

(ft)  In  addition  to  tlw  income  tax  imposed  htf  subdivision  (<i) 
of  this  sectioit  there  shall  be  levied,  assessed,  collected,  and  paid 
annually  an  additional  tax  of  ten  per  centum  upon  the  amount, 
remaining  undistributed  six  montlis  after  tlie  end  of  each  calendar 
or  fiscal  year,  of  the  total  net  income  of  every  corporation,  joint- 
stock  company  or  association,  or  insurance  company,  received  dur- 
ing the  year,  as  determined  for  the  purposes  of  the  tox  imposed 
hy  snch  subdivision  (a),  but  not  including  the  amount  of  any 
income  taxes  paid  by  it  within  the.  year  imposed  by  the  authority 
of  the  United  States.  The  tax  imposed  by  this  subdivision  shall 
not  apply  to  that  portion  of  such  undistributed  net  income  which 
.<  actually  invested  and  employed  in  the  business  or  is  retained 
for  employment  in  the  reasonable  requirements  of  the  bumness 


570  APPENDIX 

or  is  invested  in  obligations  of  the  United  States  issued  after 
September  first,  nineteen  hundred  a7id  seventeen:  Provided,  That 
if  the  Secretary  of  the  Treasury  ascertains  and  finds  that  any 
portion  of  such  amount  so  retained  at  any  time  for  employment 
in  the  bu^ness  is  n^t  so  employed  or  is  not  reasonably  required  in 
the  business  a  tax  of  fifteen  per  centum  shall  be  levied,  assessed, 
collected,  and  paid  thereon.  The  foregoing  tax  rates  shall  apply 
to  the  undistributed  net  in-come  received  by  every  taxable  corpora- 
tion,  joint-stocTc  company  or  association,  or  insurance  company  in 
the  calendar  year  mneteen  hundred  and  seventeen  and  in  each 
year  tJiereafter,  except  that  if  it  has  fixed  its  own  fiscal  year 
under  the  provisions  of  existing  law,  tJie  foregoing  rates  sJuill 
apply  to  the  proportion  of  the  taxable  undistributed  net  income 
returned  for  the  fiscal  year  ending  prior  to  December  thirty-first, 
nineteen  hundred  and  seventeen,  which  the  period  between  January 
first,  nineteen  hundred  and  seventeen,  and  the  end  of  such  fiscal 
year  bears  to  tlte  wliole  of  such  fiscal  year. 

CONDITIONAL  AND  OTHER  EXEMPTIONS 

Sec.  11.  (a)  That  there  shall  not  be  taxed  under  this  title 
any  income  received  by  any — 

First.     Labor,  agricultural,   or  horticultural   organization; 

Second.  Mutual  savings  bank  not  having  a  capital  stock  rep- 
resented by  shares; 

Third.  Fraternal  beneficiary  society,  order,  or  association, 
operated  under  the  lodge  system  or  for  the  exclusive  benefit  of 
the  members  of  a  fraternity  itself  operating  under  the  lodge  sys- 
tem, and  providing  for  the  payment  of  life,  sick,  accident,  or 
other  benefits  to  the  members  of  such  society,  order,  or  associa- 
tion or  their  dependents; 

Fourth.  Domestic  building  and  loan  association  and  co-op- 
erative banks  without  capital  stock  organized  and  operated  for 
mutual  purposes  and  without  profit; 

Fifth.  Cemetery  company  owned  and  operated  exclusively  for 
the  benefit  of  its  members; 

Sixth.  Corporation  or  association  organized  and  operated 
exclusively  for  religious,  charitable,  scientific,  or  educational  pur- 
poses, no  part  of  the  net  income  of  which  inures  to  the  benefit  of 
any  private  stockholder  or  individual; 

Seventh.     Business  league,  chamber  of  commerce,  or  board  of 


TEXT  OP  1916    LAW  AS  AMENDED  571 

trade,  not  organized  for  profit  and  no  part  of  the  net  income  of 
which  inures  to  the  benefit  of  any  private  stockholder  or  indi- 
vidual ; 

Eighth.  Civic  league  or  organization  not  organized  for  profit 
but  operated  exclusively  for  the  promotion  of  social  welfare; 

Ninth.  Club  organized  and  operated  exclusively  for  pleasure, 
recreation,  and  other  non-profitable  purposes,  no  part  of  the  net 
income  of  which  inures  to  the  benefit  of  any  private  stockholder 
or  member; 

Tenth.  Farmers'  or  other  mutual  hail,  cyclone,  or  fire  insur- 
ance company^  mutual  ditch  or  irrigation  company,  mutual  or 
co-operative  telephone  company,  or  like  organization  of  a  purely 
local  character,  the  income  of  which  consists  solely  of  assessments, 
dues,  and  fees  collected  from  members  for  the  sole  purpose  of 
meeting  its  expenses; 

Eleventh.  Farmers',  fruit  growers',  or  like  association,  or- 
ganized and  operated  as  a  sales  agent  for  the  purpose  of  market- 
ing the  products  of  its  members  and  turning  back  to  them  the 
proceeds  of  sales,  less  the  necessary  selling  expenses,  on  the  basis 
of  quantity  of  produce  furnished  by  them; 

Twelfth.  Corporation  or  association  organized  for  the  exclu- 
sive purpose  of  holding  title  to  property,  collecting  income  there- 
from, and  turning  over  the  entire  amount  thereof,  less  expenses, 
to  an  organization  which  itself  is  exempt  from  the  tax  imposed 
by  this  title;   or 

Thirteenth.  Federal  land  banks  and  national  farm-loan  as- 
sociations as  provided  in  section  twenty-six  of  the  Act  approved 
July  seventeenth,  nineteen  hundred  and  sixteen,  entitled  "An  Act 
to  provide  capital  for  agricultural  development,  to  create  standard 
forms  of  investment  based  upon  farm  mortgage,  to  equalize  rates 
of  interest  upon  farm  loans,  to  furnish  a  market  for  United  States 
bonds,  to  create  Government  depositaries  and  financial  agents  for 
the  United  States,  and  for  other  purposes." 

Fourteenth.  Joint-stock  land  banks  as  to  income  derived 
from  bonds  or  debentures  of  other  joint-stock  land  banks  or  any 
Federal  land  ])ank  belonging  to  such  joint-stock  land  bank. 

(h)  There  shall  not  be  taxed  under  this  title  any  income 
derived  from  any  public  utility  or  from  the  exercise  of  any  essen- 
tial governmental  function  accruing  to  any  State,  Territory,  or 
the  District  of  Columbia,  or  any  political  subdivision  of  a  State 
or  Territory,  nor  any  income  accruing  to  the  government  of  the 


572  APPENDIX 

Philippine  Islands  or  Porto  Rico,  or  of  any  political  subdivision 
01  the  Philippine  Islands  or  Porto  Rieo:  Provided,  That  when- 
ever any  State^  Territory,  or  the  District  of  Columbia,  or  any 
political  subdivision  of  a  State  or  Territory,  has,  prior  to  the  pas- 
sage of  this  title,  entered  in  good  faith  into  a  contract  with  any 
person  or  corporation,  the  object  and  purpose  of  which  is  to 
acquire,  construct,  operate,  or  maintain  a  public  utility,  no  tax 
shall  be  levied  under  the  provisions  of  this  title  upon  the  income 
derived  from  the  operation  of  such  public  utility,  so  far  as  the 
payment  thereof  will  impose  a  loss  or  burden  upon  such  State, 
Territory,  or  the  District  of  Columbia,  or  a  political  subdivision 
of  a  State  or  Territory;  but  this  provision  is  not  intended  to  con- 
fer upon  such  person  or  corporation  any  financial  gain  or  exemp- 
tion or  to  relieve  sucli  person  or  corporation  from  the  payment 
of  a  tax  as  provided  for  in  this  title  upon  the  part  or  portion  of 
the  said  income  to  which  such  person  or  corporation  shall  be 
entitled  under  such  contract. 

DEDUCTIONS 

See.  12.  (a)  In  the  case  of  a  corporation,  joint-stock  com- 
jjany  or  association,  or  insurance  company,  organized  in  -the 
United  States,  such  net  income  shall  be  ascertained  by  deducting 
from  the  gross  amount  of  its  income  received  within  the  year 
from  all  sources — 

First.  All  the  ordinaiy  and  necessary  expenses  paid  within 
the  year  in  the  maintenance  and  operation  of  its  business  and 
properties,  including  rentals  or  other  payments  required  to  be 
made  as  a  condition  to  the  continued  use  or  possession  of  property 
to  which  the  corporation  has  not  taken  or  is  not  taking  title,  or 
in  which  it  has  no  equity; 

Second.  All  losses  actually  sustained  and  charged  off  within 
the  year  and  not  compensated  by  insurance  or  otherwise,  including 
a  reasonable  allowance  for  the  exhaustion,  wear  and  tear  of  prop- 
erty arising  out  of  its  use  of  employment  in  the  business  or  trade; 
(a)  in  the  case  of  oil  and  gas  wells  a  reasonable  allowance  for 
actual  reduction  in  flow  and  production,  to  be  ascertained  not  by 
the  flush  flow  but  by  the  settled  production  or  regular  flow; 
(ft)  in  the  case  of  mines  a  reasonable  allowance  for  depletion 
thereof  not  to  exceed  the  market  value  in  the  mine  of  the  product 
thereof  which  has  been  mined  and  sold  during  the  year  for  which 


TEXT   OF  1916   LAW   AS  AMENDED  573 

tlio  return  suid  computation  are  made,  such  reasonable  allowance 
to  be  made  in  the  case  of  both  (o)  and  (6)  under  rules  and  regu- 
lations to  be  prescribed  by  the  Secretary  of  the  Treasury :  Pro- 
vided, That  when  the  allowance  authorized  in  (a)  and  (6)  shall 
etiual  the  capital  originally  invested,  or  in  case  of  purchase  made 
prior  to  MarcTi  first,  nineteen  hundred  and  thirteen,  the  fair  mar- 
ket value  as  of  that  date,  no  further  allowance  shall  be  made; 
and  (c)  in  the  case  of  insurance  companies,  the  net  addition,  if 
any,  required  by  law  to  be  made  within  the  year  to  reserve  funds 
and  the  sums  other  than  dividends  paid  within  the  year  on  policy 
and  annuity  contracts:  Provided,  That  no  deduction  shall  be 
allowed  for  any  amount  paid  out  for  new  buildings,  permanent 
improvements,  or  betterments  made  to  increase  the  value  of  any 
property  or  estate,  and  no  deduction  shall  be  made  for  any  amount 
of  expense  of  restoring  property  or  making  good  the  exhaustion 
thereof  for  which  an  allowance  is  or  has  been  made:  Provided 
further,  That  mutual  fire  and  mutual  employers'  liability  and 
mutual  workmen's  compensation  and  mutual  casualty  insurance 
companies  requiring  their  members  to  make  premium  deposits  to 
provide  for  losses  and  expenses  shall  not  return  as  income  any 
portion  of  the  premium  deposits  returned  to  their  policyholders, 
but  shall  return  as  taxable  income  all  income  received  by  them 
from  all  other  sources  plus  such  portions  of  their  premium  depos- 
its as  are  retained  by  the  companies  for  purposes  other  than  the 
payment  of  losses  and  expenses  and  reinsurance  reserves:  Pro- 
vided further,  That  mutual  marine  insurance  companies  shall  iu- 
I'lude  in  their  return  of  gross  income  gross  premiums  coUectetl 
and  received  by  them  less  amounts  paid  for  reinsurance,  but  sliall 
be  entitled  to  include  in  deductions  from  gross  income  amounts 
repaid  to  }>olicyholders  on  account  of  premiums  previously  paid 
by  them  and  interest  paid  upon  such  amounts  between  the  ascer- 
tainment thereof  and  the  payment  thereof,  and  life  insurance  com- 
jianies  shall  not  include  as  income  in  any  year  such  portion  of  any 
actual  premium  received  from  any  individual  policyholder  as  shall 
liave  been  paid  back  or  credited  to  such  individual  policyholder,  or 
treated  as  an  abatement  of  premium  of  such  individual  policy- 
bolder,  within  such  year. 

Third.  The  amount  of  interest  paid  within  the  year  on  its 
indebtedness  (except  on  indebtednest  ine%iirred  for  the  purch(utr 
of  obligations  or  a«amities  the  interest  ytpon  which  is  exempt 
from  idaeation  as  income  vnder  this  title)  to  an  amount  of  such 


574  APPENDIX 

indebtedness  not  in  excess  of  the  sum  of  (o)  the  entire  amount 
of  the  paid-up  capital  stock  outstanding  at  the  close  of  the  year, 
or,  if  no  capital  stock,  the  entire  amount  of  capital  employed  in 
the  business  at  the  close  of  the  year,  and  (b)  one-half  of  its 
interest-bearing  indebtedness  then  outstanding:  Provided,  That 
for  the  purpose  of  this  title  preferred  capital  stock  shall  not  be 
considered  interest-bearing  indebtedness,  and  interest  or  divi- 
dends paid  upon  this  stock  shall  not  be  deductible  from  gross 
income:  Provided  further.  That  in  cases  wherein  shares  of  cap- 
ital stock  are  issued  without  par  or  nominal  value,  the  amount 
of  paid-up  capital  stock,  within  the  meaning  of  this  section, 
as  represented  by  such  shares,  will  be  the  amount  of  cash,  or  its 
equivalent,  paid  or  transferred  to  the  corporation  as  a  considera- 
tion for  such  shares:  Provided  further,  That  in  the  case  of 
indebtedness  wholly  secured  by  property  collateral,  tangible  or 
intangible,  the  subject  of  sale  or  hypothecation  in  the  ordinary 
business  of  such  corporation,  joint-stock  company  or  association 
as  a  dealer  only  in  the  property  constituting  such  collateral,  or  in 
loaning  the  funds  thereby  procured,  the  total  interest  paid  by 
such  corporation,  company,  or  association  within  the  year  on  any 
such  indebtedness  may  be  deducted  as  a  part  of  its  expenses  of 
doing  business,  but  interest  on  such  indebtedness  shall  only  be 
deductible  on  an  amount  of  such  indebtedness  not  in  excess  of 
the  actual  value  of  such  property  collateral:  Provided  further. 
That  in  the  case  of  bonds  or  other  indebtedness,  which  have  been 
issued  with  a  guaranty  that  the  interest  payable  thereon  shall 
be  free  from  taxation,  no  deduction  for  the  payment  of  the  tax 
herein  imposed,  or  any  other  tax  paid  pursuant  to  such  .guaranty, 
shall  be  allowed;  and  in  the  case  of  a  bank,  banking  association, 
loan  or  trust  company,  interest  paid  within  the  year  on  deposits 
or  on  moneys  received  for  investment  and  secured  by  interest- 
bearing  certificates  of  indebtedness  issued  by  such  bank,  banking 
association,  loan  or  trust  company,  shall  be  deducted; 

Fourth.  Taxes  paid  within  the  year  imposed  by  the  authority 
of  the  United  States  {except  income  and  excess  profits  taxes), 
or  of  its  Territories,  or  possessions,  or  any  foreign  country,  or  by 
the  authority  of  any  State,  county,  school  district,  or  municipality, 
or  other  taxing  subdivision  of  any  State,  not  including  those 
assessed  against  local  benefits. 

(6)  In  the  case  of  a  corporation,  joint-stock  company  or  asso- 
ciation, or  insurance  company,  organized,  a\ithorized,  or  existing 


TEXT   OF  1916    LAW   AS  AMENDED  575 

• 
under  the  laws  of  any  foreign  country,  such  net  income  shall  be 
ascertained  by  deducting  from  tne  gross  amount  of  its  income 
received  within  the  year  from  all  sources  witn  the  United  States — 

First.  All  the  ordinary  and  necessary  expenses  actually  paid 
within  the  year  out  gf  earnings  in  the  maintenance  and  operation 
of  its  business  and  property  within  the  United  States  including 
rentals  or  other  payments  required  to  be  made  as  a  condition 
to  the  continued  use  or  possession  of  property  to  which  the  cor- 
poration has  not  taken  or  is  not  taking  title,  or  in  which  it  has 
no  equity; 

Second.  All  losses  actually  sustained  within  the  year  in  busi- 
ness or  trade  conducted  by  it  witliin  the  United  States  and  not 
compensated  by  insurance  or  otherwise,  including  a  reasonable 
allowance  for  the  exhaustion,  wear  and  tear  of  property  arising 
out  of  its  use  or  employment  in  the  business  or  trade;  (a)  and 
in  tho  case  of  oil  and  gas  wells  a  reasonable  allowance  for  actual 
reduction  in  flow  and  production  to  be  ascertained  not  by  the  flush 
flow,  but  by  the  settled  production  or  regular  flow;  (ft)  in  the  case 
of  mines  a  reasonable  allowance  for  depletion  thereof  not  to  ex- 
ceed the  market  value  in  the  mine  of  the  product  thereof  which 
has  been  mined  and  sold  during  the  year  for  which  the  return 
and  computation  are  made,  such  reasonable  allowance  to  be  made 
in  the  case  of  both  (a)  and  (6)  under  rules  and  regulations  to 
be  prescribed  by  the  Secretary  of  the  Treasury:  Provided,  That 
when  the  allowance  authorized  in  (a)  and  (b)  shall  equal  the 
capital  originally  invested,  or  in  case  of  purchase  made  prior  to 
March  first,  nineteen  hundred  and  thirteen,  the  fair  market  value 
as  of  that  date,  no  further  allowance  shall  be  made;  and  (c)  in 
the  case  of  insurance  companies  the  net  addition,  if  any,  required 
by  law  to  be  made  within  the  year  <to  reserve  funds  and  the  sums 
other  than  dividends  paid  within  the  year  on  policy  and  annuity 
contracts:  Provided,  That  no  deduction  shall  be  allowed  for  any 
amount  paid  out  for  new  buildings,  permanent  improvements,  or 
betterments,  made  to  increase  the  value  of  any  property  or  estate, 
and  no  deduction  shall  be  made  for  any  amount  of  expense  of 
restori^ig  property  or  making  good  the  exhaustion  thereof  for 
which  an  allowance  is  or  has  been  made;  Provided  further,  That 
mutual  fire  and  mutual  employers'  liability  and  mutual  work- 
men 's  compensation  and  mutual  casualty  insurance  companies 
requiring  their  members  to  make  premium  deposits  to  provide 
for  losses  and  expenses  shall  not  return  as  income  any  portion  of 


576  APPENDIX 

* 
tlio  prcmiuiii  deposits  returned  to  their  policyholders,  but  shall 
return  as  taxable  income  all  income  received  by  them  from  all 
other  sources  plus  such  portions  of  the  premium  deposits  as  are 
retained  by  the  companies  for  purposes  other  than  the  payment  of 
losses  and  exjienses  and  reinsurance  reserves:  Provided  further, 
That  mutual  marine  insurance  companies  shall  include  in  their 
return  of  gi-oss  income  gross  premiums  collected  and  received  by 
them  less  amounts  paid  for  reinsurance,  but  shall  be  entitled  to  in- 
clude in  deductions  from  gross  income  amounts  repaid  to  policy- 
holders on  account  of  premiums  previously  paid  by  them  and 
interest  paid  upon  such  amounts  between  the  ascertainment  thereof 
and  the  payment  thereof,  and  life  insurance  companies  shall  not 
include  as  income  in  any  year  such  portion  of  any  actual  premium 
received  from  any  individual  policyholder  as  shall  have  been  paid 
back  or  credited  to  such  individual  policyholder,  or  treated  as  an 
abatement  of  premium  of  such  individual  policyholder,  within 
such  year; 

Third.  The  amount  of  interest  paid  within  the  year  on  its 
indebtedness  {except  on  indebtedness  incurred  for  the  purchase 
of  obligations  or  securities  the  interest  upon  which  is  exempt 
from  taxation  as  income  under  this  title)  to*  an  amount  of  such  in- 
debtedness not  in  excess  of  the  proportion  of  the  sum  of  (a)  the 
entire  amount  of  the  paid-up  capital  stock  outstanding  at  the 
close  of  the  year,  or,  if  no  capital  stock,  the  entire  amount  of  the 
capital  employed  in  the  business  at  the  close  of  the  year,  and  (b) 
one-half  of  its  interest-bearing  indebtedness  then  outstanding, 
which  the  gross  amount  of  its  income  for  the  year  from  business 
transacted  and  capital  invested  within  the  United  States  bears 
to  the  gi'oss  amount  of  its  income  derived  from  all  sources  within 
and  without  the  United  States:  Provided,  That  in  the  case  of 
bonds  or  other  indebtedness  Avhieh  have  been  issued  with  a  guar- 
anty that  the  interest  payable  thereon  shall  be  free  from  taxation, 
no  deduction  for  the  payment  of  the  tax  herein  imposed  or  any 
other  tax  paid  pursuant  to  such  guaranty  shall  be  allowed;  and 
in  case  of  a  bank,  banking  association,  loan  or  trust  company,  or 
branch  thereof,  interest  paid  within  the  year  on  deposits,  by  or 
on  moneys  received  for  investment  from  either  citizens  or  resi- 
dents of  the  United  States  and  secured  by  interest-bearing  cer- 
tificates of  indebtedness  issued  by  such  bank,  banking  association, 
loan  or  trust  company,  or  branch  thereof; 


TEXT   OF  1916    LAW   AS  AMENDED  577 

Fourth.  Taxes  paid  within  the  year  imposed  by  the  authority 
of  the  United  States  {except  income  and  excess  profits  taxes),  or 
of  its  Territories  or  possessions,  of  by  the  authority  of  any  State, 
i-ounty,  school  district,  or  municipality,  or  other  taxing  subdivision 
of  any  State,  paid  within  the  United  States,  not  including  those 
assessed  aganst  local  benefits. 

(c)  In  the  case  of  assessment  insurance  companies,  whether 
domestic  or  foreign,  the  actual  deposit  of  sums  with  State  or 
Territorial  officers,  pursuant  to  law,  as  additions  to  guarantee  of 
reserve  funds  shall  be  treated  as  being  payments  required  by 
law  to  reserve  funds. 

RETURNS. 

Sec.  13.  (a)  The  tax  shall  be  computed  upon  the  net  income, 
as  thus  ascertained,  received  within  each  preceding  calendar  year 
<>nding  December  thirty-first:  Provided,  That  any  corporation, 
joint-stock  company  or  association,  or  insurance  company,  subject 
to  this  tax,  may  designate  the  last  day  of  any  month  in  the  year 
as  the  day  of  the  closing  of  its  fiscal  year  and  shall  be  entitled 
to  have  the  tax  payable  by  it  computed  upon  the  basis  of  the 
net  income  ascertained  as  herein  provided  for  the  year  ending 
on  the  day  so  designated  in  the  year  preceding  the  date  of 
assessment  instead  of  upon  the  basis  of  the  net  income  for  the 
calendar  year  preceding  the  date  of  assessment;  and  it  shall  give 
notice  of  the  day  it  has  thus  designated  as  the  closing  of  its 
fiscal  year  to  the  collector  of  the  district  in  which  its  principal 
liusiness  office  is  located  at  any  time  not  less  than  thirty  days 
prior  to  the  first  day  of  March  of  the  year  in  which  its  return 
would  be  filed  if  made  upon  the  basis  of  the  calendar  year; 

(6)  Every  corporation,  joint-stock  company  or  association,  or 
insurance  company,  subject  to  the  tax  herein  imposed,  shall,  on  or 
Itefore  the  first  day  of  March  nineteen  hundred  and  seventeen, 
and  the  first  day  of  March  in  each  year  thereafter,  or,  if  it  has 
designated  a  fiscal  year  for  the  computation  of  its  tax,  then  within 
sixty  days  after  the  close  of  such  fiscal  year  ending  prior  to 
December  thirty-first,  nineteen  hundred  and  sixteen,  and  the  close 
of  each  such  fiscal  year  thereafter,  render  a  true  and  accurate 
return  of  its  annual  net  income  in  the  manner  and  form  to  be 
|)rescribetl  by  the  Commissioner  of  Internal  Revenue,  with  the 
approval  of  the  Secretary  of  the  Treasury,  and  containing  such 
F.  I.  Tax.--37. 


578  APPENDIX 

facts,  data,  and  information  as  are  appropriate  and  in  the  opinion 
of  the  commissioner  necessary  to  determine  the  correctness  of 
the  net  income  returned  and  to  carry  out  the  provisions  of  this 
title.  The  return  shall  be  sworn  to  by  the  president,  vice  presi- 
dent, or  other  principal  oflScer,  and  by  the  treasurer  or  assistant 
treasurer.  The  return  shall  be  made  to  the  collector  of  the  district 
in  which  is  located  tlie  principal  office  of  the  corporation,  com- 
pany, or  association,  where  are  kept  its  books  of  account  and 
other  data  from  which  the  return  is  prepared,  or  in  the  case 
of  a  foreign  corporation,  company,  or  association,  to  the  collector 
of  the  district  in  which  is  located  itsi  principal  place  of  business 
in  the  United  States,  or  if  it  have  no  principal  place  of  business, 
office,  or  agency  in  the  United  States,  then  to  the  collector  of 
internal  revenue  at  Baltimore,  Maryland.  All  such  returns  shall  as 
received  be  transmitted  forthwith  by  the  collector  to  the  Commis- 
sioner of  Internal  Revenue; 

(c)  In  cases  wherein  receivers,  trustees  in  bankruptcy,  or 
assignees  are  operating  the  property  or  business  of  corporations, 
joint-stock  companies  or  associations,  or  insurance  companies, 
subject  to  tax  imposed  by  this  title,  such  receivers,  trustees,  or 
assignees  shall  make  returns  of  net  income  as  and  for  such  cor- 
porations, joint-stock  companies  ur  associations,  and  insurance 
companies,  in  the  same  manner  and  form'  as  such  organizations 
are  hereinbefore  required  to  make  returns,  and  any  income  tax 
due  on  the  basis  of  such  returns-  made  by  receivers,  trustees,  or 
assignees  shall  be  assessed  and  collected  in  the  same  mannerj  as 
if  assessed  directly  against  the  organizations  of  whose  businesses 
or  properties  they  have  custody  and  control; 

(d)  A  corporation,  joint-stock  company  or  association,  or  in- 
surance company,  keeping  accounts  upon  any  basis  other  than 
that  of  actual  receipts  and  disbursements,  unless  such  other  basis 
does  not  clearly  reflect  its  income,  may,  subject  to  regulations 
made  by  the  Commissioner  of  Internal  Revenue,  with  the  approval 
of  the  Secretary  of  the  Treasury,  make  its  return  upon  the  basis 
upon  which  its  accounts  are  kept,  in  which  case  the  tax  shall  be 
computed  upon  its  income  as  so  returned; 

(e)  All  the  provisions  of  this  title  relating  to  the  tax  author- 
ized and  required  to  be  deducted  and  withheld  and  paid  to  the 
officer  of  the  United  States  Government  authorized  to  receive  the 
same  from  the  income  of  non-resident  alien  individuals  from 
sources  within  the  United  States  shall  be  made  applicable  to  the 


TEXT   OP  1916    LAW   AS   AMENDED  579 

<flj;  imposed  by  subdivision  (<i)  of  section  ten  upon  incomes  de- 
rive<l  from  interest  upon  bonds  and  mortgages  or  deedH  of  trust 
or  similar  obligations  of  domestic  or  other  resident  corporations, 
joint-stock  companies  or  associations,  and  insurance  companies 
by  non-resident  alien  firms,  copartnerships,  companies,  corpora- 
tions, joint-stock  com])a]iies  or  associations,  and  insurance  compa- 
nies, not  engaged  in  business  or  trade  within  the  United  States 
and  not  having  any  oflSce  or  place  of  business  therein; 

(/)  Likewise,  all  the  provisions  of  this  title  relating  to  the  tax 
authorized  and  required  to  be  deducted  and  withheld  and  paid 
to  the  officer  of  the  United  States  Government  authorized  to  re- 
ceive the  same  from  the  income  of  non-resident  alien  individuals 
from  sources  within  the  United  States  shall  be  made  applicable 
to  income  derived  frwn  dividends  upon  the  capital  stock  or  from 
the  net  earnings  of  domestic  or  other  resident  corporations,  joint- 
stock  companies  or  associations,  and  insurance  companies  by  non- 
resident alien  companies,  corporations,  joint-stock  companies  or 
associations,  and  insurance  companies  not  engaged  in  business  or 
trade  within  the  United  States  and  not  having  any  office  or  place 
of  business  therein. 

ASSESSMENT  AND  ADMINISTRATION 

Sec.  14.  (a)  All  assessments  shall  be  made  and  the  several 
corporations,  joint-stock  companies  or  associations,  and  insurance 
companies  shall  be  notilied  of  the  amount  for  which  they  are 
respectively  liable  on  or  before  the  first  day  of  June  of  each  suc- 
cessive year,  and  said  assessment  shall  be  paid  on  or  before  the 
fifteenth  day  of  June:  Provided,  That  every  corporation,  joint- 
stock  company  or  association,  and  insurance  company,  computing 
taxes  upon  the  income  of  the  fiscal  year  which  it  may  designate 
in  the  manner  hereinbefore  provided,  shall  pay  the  taxes  due 
under  its  assessment  within  one  hundred  and  five  days  after  the 
date  upon  which  it  is  required  to  file  its  list  or  return  of  income 
for  assessment ;  except  in  crises  of  refusal  or  neglect  to  make  such 
return,  and  in  cases  of  erroneous,  false,  or  fraudulent  returns,  in 
which  eases  the  Commissioner  of  Internal  Revenue  shall,  upon 
tlio  discovery  thereof,  at  any  time  within  thre«>  years  after  said 
return  is  due,  make  a  return  upon  information  obtained  as  pro- 
vided for  in  this  title  or  by  existing  law;  and  the  assessment 
made  bv  the  Commissioner  of  Internal   Revenue  thereon  shall   be 


580  APPENDIX 

paid  by  sueh  corporation,  joint-stock  company  or  association,  or 
insurance  company  immediately  upon  notification  of  the  amount 
of  such  assessment;  and  to  any  sum  or  sums  due  aaid  unpaid  alter 
the  fifteenth  day  of  June  in  any  year,  or  after  one  hundred  and 
five  days  from  the  dat«  on  which  the  return  of  income  is  required 
to  be  made  by  the  taxpayer,  and  after  ten  days'  notice  and 
demand  thereof  by  the  collector,  there  shall  be  added  the  sum 
of  five  per  centum  on  the  amount  of  tax  unpaid  and  interest  at 
the  rate  of  one  per  centum  per  month  upon  said  tax  from  the 
time  the  same  becomes  due :  Provided,  That  upon  the  examination 
of  any  return  of  income  made  pursuant  to  this  title,  the  act  of 
August  fifth,  nineteen  hundred  and  nine,  entitled  *  *  An  act  to 
provide  revenue,  equalize  duties,  and  encourage  the  industries  of 
the  United  States,  and  for  other  purposes",  and  the  act  of  Octo- 
ber third,  nineteen  hundred  and  thirteen,  entitled  "An  act  to 
reduce  tariff  duties  and  to  provide  revenue  for  the  Government, 
and  for  other  purposes",  if  it  shall  appear  that  amounts  of  tax 
have  been  paid  in  excess  of  those  properly  due,  the  taxpayer  shall 
be  permitted  to  present  a  claim  for  refund  thereof  nothwithstand- 
ing  the  provisions  of  section  thirty-two  hundred  and  twenty-eight 
of  the  Revised  Statutes; 

(&)  When  the  assessment  shall  be  made,  as  provided  in  this 
title,  the  returns,  together  with  any  corrections  thereof  which 
may  have  been  made  by  the  commissioner,  shall  he  filed  in  the 
office  of  the  Commissioner  of  Internal  Revenue  and  shall  con- 
stitute public  records  and  be  open  to  inspection  as  sueh :  Pro- 
vided, That  any  and  all  such  returns  shall  be  open  to  inspection 
only  upon  the  order  of  the  President,  under  rules  and  regulations  to 
be  prescribed  by  the  Secretary  of  the  Treasury  and  approved  by 
the  President:  Provided  further.  That  the  proper  officers  of 
any  State  imposing  a  general  income  tax  may,  upon  the  request 
of  the  governor  thereof,  have  access  to  said  returns  or  to  an 
abstract  thereof,  showing  the  name  and  income  of  each  such  cor- 
poration, joint-stock  company  or  association,  or  insurance  com- 
pany, at  such  times  and  in  such  manner  as  the  Secretary  of  the 
Treasury  may  prescribe; 

(c)  If  any  of  the  corporations,  joint-stock  companies  or  asso: 
ciations,  or  insurance  companies  aforesaid  shall  refuse  or  neglect 
to  make  a  return  at  the  time  or  times  hereinbefore  specified  in 
each  year,  or  shall  render  a  false  or  fraudulent  return,  such  cor- 
j)oration,  joint-stock  com])any  or  association,  or  insurance  company 


TEXT   OF  1916    LAW    AS   AMENDED  581 

shall  be  liable  to  a  penalty  of  uot  exceeding  $10,000:  Provided, 
That  the  Commissioner  of  Internal  Revenue  shall  have  authority, 
in  the  case  of  either  corporations  or  individuals,  to  grant  a  rea- 
sonable extension  of  time  in  meritorious  cases,  as  he  may  deem 
proper ; 

(d)  That  section  thirty-two  hundred  and  twenty-five  of  tlie 
Revised  Statutes  of  the  United  States  be,  and  the  same  is  hereby, 
amended  so  as  to  read  as  follows: 

' '  Sec.  3225.  When  a  second  assessment  is  made  in  case  of  any 
list,  statement,  or  return,  which  in  the  opinion  of  the  collector  or 
deputy  collector  was  false  or  fraudulent,  or  contained  any  under- 
statement or  undervaluation,  no  tax  collected  under  such  Assess- 
ment shall  be  recovered  by  any  suit  unless  it  is  proved  that  the 
said  list,  statement,  or  return  was  not  false  nor  fraudulent  and 
did  not  contain  any  understatement  or  undervaluation;  but  this 
section  shall  not  apply  to  statements  or  returns  made  or  to  be 
made  in  good  faith  under  the  laws  of  the  United  States  regarding 
annual  depreciation  of  oil  or  gas  wells  and  mines. ' ' 

I'ART    III.— GENERAL    ADMINISTRATIVE    PROVISIONS 

Sec.  15.*  That  the  word  "State"  or  "United  States"  when 
used  in  this  title  shall  be  construed  to  include  any  Territory,  the 
District  of  Columbia,  Porto  Rico,  and  the  Philippine  Islands,  when 
sudi  construction  is  necessary  to  carry  out  its  provisions. 

Sec.  16.  That  sections  thirty-one  hundred  and  sixty-seveu, 
thirty-one  hundred  and  seventy-two,  thirty-one  hundred  and 
seventy-three,  and  thirty-one  hundred  and  seventy-six  of  the  Re- 
vise<l  Statutes  of  the  United  States  as  amended  are  hereby  amended 
so  as  to  read  as  follows: 

"Sec.  3167.  It  shall  be  unlawful  for  any  collector,  deputy 
collector,  agent,  clerk,  or  other  oflScer  or  employee  of  the  United 
States  to  divulge  or  to  make  known  in  any  manner  whatever  not 
provided  by  law  to  any  person  the  operations,  style  of  work,  or 
apparatus  of  any  manufacturer  or  producer  visited  by  him  in  tlie 
discharge  of  his  official  duties,  or  the  amount  or  source  of  income, 
jirofits,  losses,  expenditures,  or  any  particular  thereof,  set  forth  or 
disclosed  in  any  income  return,  or  to  permit  any  income  return  or 
copy  thereof  or  any  book  containing  any  abstract  or  particulars 
thereof  to  be  seen  or  examined  by  any  person  exceiit  as  provided 
by  law;  and  it  shall  Ite  unlawful  for  any  person  to  print  or  publish 


582  APPENDIX 

iu  any  manner  whatever  not  provided  by  law  any  income  return  or 
any  part  thereof  or  source  of  income,  profits,  losses,  or  erpendi- 
tures  appearing  in  any  income  return;  and  any  offense  against 
the  foregoing  provision  shall  be  a  mis<lemeanor  and  be  punished 
by  a  fine  not  exceeding  $1,000  or  by  imprisonment  not  exceeding 
one  year,  or  both,  at  the  discretion  of  the  court ;  and  if  the  offender 
be  an  officer  or  employee  of  the  United  States  he  shall  be  dismissed 
from  office  or  discharged  from  employment. 

"Sec.  3172.  Every  collector  shall,  from  time  to  time,  cause 
his  deputies  to  proceed  through  every  part  of  his  district  and 
pay  any  internal-revenue  tax,  and  all  persons  owning  or  having 
the  care  and  management  of  any  objects  liable  to  pay  any  tax, 
and  to  make  a  list  of  such  persons  and  enumerate  said  objects. 

"Sec.  3173.  It  shall  be  the  duty  of  any  person,  partnership, 
firm,  association,  or  corporation,  made  liable  to  any  duty,  special 
tax,  or  other  tax  imposed  by  law,  when  not  otherwise  provided  for, 
(1)  in  case  of  a  special  tax,  on  or  before  the  thirty-first  day  of  July 
in  each  year,  (2)  in  case  of  income  tax  on  or  before  the  first  day  of 
March  in  each  year,  or  on  or  before  the  last  day  of  the  sixty-day 
period  next  following  the  closing  date  of  the  fiscal  year  for  which 
inquire  after  and  concerning  all  persons  therein  who  are  liable  to 
it  makes  a  return  of  its  income,  and  (3)  in  other  caseS  before  the 
day  on  which  the  taxes  accrue,  to  make  a  list  or  return,  verified  by 
oath,  to  the  collector  or  a  deputy  collector  of  the  district  where 
located,  of  the  articles  or  objects,  including  the  amount  of  annual 
income  charged  with  a  duty  or  tax,  the  quantity  of  goods,  wares, 
and  merchandise,  made  or  sold  and  charged  with  a  tax,  the  several 
rates  and  aggregate  amount,  according  to  the  forms  and  regula- 
tions to  be  prescribed  by  the  Commissioner  of  Internal  Revenue, 
with  the  approval  of  the  Secretary  of  the  Treasury,  for  which  such 
person,  partnership,  firm,  association,  or  corporation  is  liable: 
Provided,  That  if  any  person  liable  to  pay  any  duty  or  tax,  or 
owning,  possessing,  or  having  the  care  or  management  of  property, 
goods,  wares,  and  merchandise,  articles  or  objects  liable  to  pay 
any  duty,  tax,  or  license,  shall  fail  to  make  and  exhibit  a  list  or 
return  required  by  law,  but  shall  consent  to  disclose  the  particulars 
of  any  and  all  the  property,  goods,  wares,  and  merchandise,  articles, 
and  objects  liable  to  pay  any  duty  or  tax,  or  any  business  or 
occupation  liable  to  pay  any  tax  as  aforesaid,  then,  and  in  that 
case,  it  shall  be  the  duty  of  the  collector  or  deputy  collector  to 
make  such  list  or  return,  which,  being  distinctly  read,  consented 


TEXT   OP  1916    LAW   AS  AMENDED  583 

to,  and  signed  and  verified  by  oath  by  the  person  so  owning, 
jiossessing,  or  hanng  the  care  and  management  as  aforesaid,  may 
ho  received  as  the  list  of  such  person:  Provided  further,  That  in 
case  no  annual  list  or  return  has  been  rendered  by  such  ])er80u 
to  the  collector  or  deputy  collector  as  required  by  law,  and  the 
person  shall  be  absent  from  his  or  her  residence  or  place  of  busi- 
ness at  the  time  the  collector  or  a  deputy  collector  shall  call  for 
the  annual  list  or  return,  it  shall  be  the  duty  of  such  collector  or 
deputy  collector  to  leave  at  such  place  of  residence  or  business, 
with  some  one  of  suitable  age  and  discretion,  if  such  be  present, 
otherwise  to  deposit  in  the  nearest  postoffice,  a  note  or  memoran- 
dum addressed  to  such  person,  requiring  him  or  her  to  render  to 
such  collector  or  deputy  collector  the  list  or  return  required  by 
law  within  ten  days  from  the  date  of  such  note  or  memorandum, 
verified  by  oath.  And  if  any  person,  on  being  notified  or  require<l 
as  aforesaid,  shall  refuse  or  neglect  to  render  such  list  or  return 
within  the  time  required  as  aforesaid,  or  whenever  any  person  who 
is  required  to  deliver  a  monthly  or  other  return  of  objects  subject 
to  tax  fails  to  do  so  at  the  time  required,  or  delivers  any  return 
which,  in  the  opinion  of  the  collector,  is  erroneous,  false,  or 
fraudulent,  or  contains  any  undervaluation  or  understatement,  or 
refuses  to  allow  any  regularly  authorized  Government  oflScer  to 
examine  the  books  of  such  person,  firm,  or  corporation,  it  shall  be 
lawful  for  the  collector  to  summon  such  person,  or  any  other  per- 
son having  possession,  custody,  or  care  of  books  of  account  con- 
taining entries  relating  to  the  business  of  such  person,  or  any 
other  person  he  may  deem  proper,  to  appear  before  him  and 
produce  such  books  at  a  time  and  place  named  in  the  summons, 
and  to  give  testimony  or  answer  interrogatories,  under  oath,  re- 
specting any  objects  or  income  liable  to  tax  or  the  returns  thereof. 
The  collector  may  summon  any  person  residing  or  found  within 
the  State  or  Territory  in  which  his  district  lies;  and  when  the 
person  intended  to  be  summoned  does  not  reside  and  can  not  be 
found  within  such  State  or  Territory,  he  may  enter  any  collection 
district  where  such  person  may  be  found  and  there  make  the 
examination  herein  authorized.  And  to  this  end  he  may  there 
exercise  all  the  authority  which  he  might  lawfully  exercise  in  the 
district  for  which  he  was  commissioned :  Provided,  That  '  person, ' 
as  used  in  this  section,  shall  be  construed  to  include  any  corpora 
tion,  joint-stock  company  or  association,  or  insurance  company 
when  such  construction  is  necessary  to  carry  out  its  provisions. 


584  APPENDIX 

"Sec.  3176.  If  any  person,  corporation,  company,  or  associa- 
tion fails  to  make  and  file  a  return  or  list  at  the  time  prescribed 
by  law,  or  makes,  willfully  or  otherwise,  a  false  or  fraudulent 
return  or  list,  the  collector  or  deputy  collector  shall  make  the 
return  or  list  from  his  own  knowledge  and  from  such  information 
as  he  can  obtain  through  testimony  or  otherwise.  Any  return  or 
list  so  made  and  subscribed  by  a  collector  or  deputy  collector 
shall  be  prima  facie  good  and  sufficient  for  all  legal  purposes. 

"If  the  failure  to  file  a  return  or  list  is  due  to  sickness  or 
absence  the  collector  may  allow  such  further  time,  not  exceeding 
thirty  days,  for  making  and  filing  the  return  or  list  as  he  deems 
proper. 

* '  The  Commissioner  of  Internal  Revenue  shall  assess  all  taxes, 
other  than  stamp  taxes,  as  to  which  returns  or  lists  are  so  made 
l)y  a  collector  or  deputy  collector.  In  case  of  any  failure  to  make 
and  file  a  return  or  list  within  the  time  prescribed  l)y  law  or  by 
the  collector,  the  Commissioner  of  Internal  Revenue  shall  add  to 
the  tax  fifty  per  centum  of  its  amount  except  that,  when  a  return 
is  voluntarily  and  without  notice  from  the  collector  filed  after 
such  time  and  it  is  shown  that  the  failure  to  file  it  was  due  to  a 
reasonable  cause  and  not  to  willful  neglect,  no  such  addition  shall 
be  made  to  the  tax.  In  case  a  false  or  fraudulent  return  or  list  is 
willfully  made,  the  Commissioner  of  Internal  Revenue  shall  add  to 
the  tax  one  hundred  per  centum  of  its  amount. 

*  *  The  amount  so  added  to  any  tax  shall  be  collected  at  the 
same  time  and  in  the  same  manner  and  as  part  of  the  tax  unless 
the  tax  has  been  paid  before  the  discovery  of  the  neglect,  falsity, 
or  fraud,  in  which  case  the  amount  so  added  shall  he  collected  in 
the  same  manner  as  the  tax." 

Sec.  17.  That  it  shall  be  the  duty  of  every  collector  of  internal 
revenue,  to  whom  any  payment  of  any  taxes  is  made  under  the 
provisions  of  this  title,  to  give  to  the  person  making  such  payment 
a  full  written  or  printed  receipt,  expressing  the  amount  paid  and 
the  particular  account  for  which  such  payment  was  made;  and 
whenever  such  ])ayment  is  made  sucli  collector  shall,  if  required, 
give  a  separate  receipt  for  each  tax  paid  by  any  debtor,  on  account 
of  payments  made  to  or  to  be  made  by  him  to  separate  creditors  in 
such  form  that  such  debtor  can  conveniently  produce  the  same 
separately  to  his  several  creditors  in  satisfaction  of  their  respective 
demands  to  the  amounts  specified  in  such  receipts;  and  such 
receipts  shall   be   sufficient  evidence   in   favor   of   such   del)tor   to 


TEXT   OP  1916    LAW   AS  AMENDED  585 

justify  him  in  withholding  the  amount  therein  expressed  from  his 
next  payment  to  hie  creditor;  but  such  creditor  may,  upon  giving 
to  his  debtor  a  full  written  receipt,  acknowledging  the  payment 
to  him  of  whatever  sum  may  be  actually  paid,  and  accepting  the 
amount  of  tax  paid  as  aforesaid  (specifying  the  same)  as  a  fur- 
ther satisfaction  of  the  debt  to  that  amount,  require  the  surrender 
to  him  of  such  collector 's  receipts. 

Sec.  18.  That  any  person,  corporation,  paHnership,  associa- 
tion, or  insurance  company,  liable  to  pay  the  tax,  to  make  o  return 
or  to  supply  information  required  under  this  title,  vfho  refuse*  or 
neglect*  to  pay  sm-h  tax,  to  make  such  return  or  to  supply  such 
information  at  the  time  or  times  herein  specified  in  each  year, 
shall  be  liable,  except  as  otlwrwise  specially  provided  in  this  title, 
to  a  penalty  of  not  less  than  $20  nor  more  than  $1,000.  Any 
individual  or  any  officer  of  any  corporation,  partnership,  asso- 
ciation, or  insurance  company,  required  by  law  to  make,  render, 
sign,  or  verify  any  return  or  to  supply  any  information,  who 
makes  any  false  or  fraudulent  return  or  statement  with  intent 
to  defeat  or  evade  the  assessment  required  by  this  title  to  be 
made,  shall  be  guilty  of  a  misdemeanor,  and  shall  be  fined  not 
exceeding  $2,000  or  be  imprisoned  not  exceeding  one  year,  or 
both,  in  the  discretion  of  the  court,  with  the  coats  of  prosecu- 
tion: Provided,  That  where  any  tax  heretofore  due  and  pay- 
able has  been  duly  paid  by  the  taxpayer,  it  shall  not  be  re-collected 
from  any  withholding  agent  required  to  retain  it  at  its  source,  nor 
shall  any  penalty  be  imposed  or  collected  in  such  cases  from  the 
taxpayer,  or  such  withholding  agent  whose  dutj?  it  was  to  retain  it, 
for  failure  to  return  or  jtay  the  same,  unless  such  failure  was 
fraudulent  and  for  the  purpose  of  evading  payment. 

Sec.  19.  The  collector  or  deputy  collector  shall  require  every 
return  to  be  verified  by  the  oath  of  the  party  rendering  it.  If  the 
collector  or  deputy  collector  have  reason  to  believe  that  the  amount 
of  any  income  returned  is  understated,  he  shall  give  due  notice  to 
the  person  making  the  return  to  show  cause  why  the  amount  of 
the  return  should  not  be  increased,  and  upon  proof  of  the  amount 
understated  may  increase  the  same  accordingly.  Such  person  may 
furnish  sworn  testimony  to  prove  any  relevant  facts,  and,  if  dis- 
satisfied with  ^the  decision  of  tiio  collector,  may  n|)|K>al  to  the 
Commissioner  of  Internal  Revenue  for  his  decision  under  such 
rules  of  procedure  as  may  be  prescrilied  by  regulation. 

Sw,  ?0,    Th^t  jurisdiction  is  hereby  eonferre<l  upon  the  district 


586  APPENDIX 

courts  of  the  United  States  for  the  district  within  which  any  per- 
son summoned  under  this  title  to  appear  to  testify  or  to  produce 
books  shall  reside,  to  compel  such  attendance,  production  of  books, 
and  testimony  by  appropriate  process. 

Sec.  21.  That  the  preparation  and  publication  of  statistics 
reasonably  available  with  respect  to  the  operation  of  the  income 
tax  law  and  containing  classifications  of  taxpayers  and  of  income, 
the  amounts  allowed  as  deductions  and  exemptions,  and  any  other 
facts  deemed  pertinent  and  valuable,  shall  be  made  annually  by 
the  Commissioner  of  Internal  Kevenue  with  the  approval  of  the 
Secretary  of  the  Treasury. 

Sec.  22.  That  all  administrative,  special,  and  general  provisions 
of  law,  including  the  laws  in  relation  to  the  assessment,  remission, 
collection,  and  refund  of  internal-revenue  taxes  not  heretofore 
specifically  repealed  and  not  inconsistent  with  the  provisions  of 
this  title,  are  hereby  extended  and  made  applicable  to  all  the 
provisions  of  this  title  and  to  the  tax  herein  imposed. 

Sec.  23.  That  the  provisions  of  this  title  shall  extend  to  Porto 
Rico  and  the  Philippine  Islands:  Provided,  That  the  administra- 
tion of  the  law  and  the  collection  of  the  taxes  imposed  in  Porto 
Rico  and  the  Philippine  Islands  shall  be  by  the  appropriate  in- 
ternal-revenue oflScers  of  those  governments,  and  all  revenues 
collected  in  Porto  Rico  and  the  Philippine  Islands  thereunder  shall 
accrue  intact  to  the  general  governments  thereof,  respectively : 
Provided  further.  That  the  jurisdiction  in  this  title  conferred 
upon  the  district  courts  of  the  United  States  shall,  so  far  as  the 
Philippine  Islands  'are  concerned,  be  vested  in  the  courts  of  the 
first  instance  of  said  islands :  And  provided  further.  That  nothing 
in  this  title  shall  be  held  to  exclude  from  the  computation  of  the 
net  income  the  compensation  paid  any  official  by  the  governments 
of  the  District  of  Columbia,  Porto  Rico,  and  the  Philippine  Islands, 
or  the  political  subdivisions  thereof. 

Sec.  24.  That  Section  II  of  the  Act  approved  October  third, 
nineteen  hundred  and  thirteen,  entitled  "An  Act  to  reduce  tariff 
duties  and  to  provide  revenue  for  the  Government,  and  for  other 
purposes, ' '  is  hereby  repealed,  except  as  herein  otherwise  provided, 
and  except  that  it  shall  remain  in  force  for  the  assessment  and 
collection  of  all  taxes  which  have  accrued  thereunder,  and  for  the 
imposition  and  collection  of  all  penalties  or  forfeitures  wliich  have 
accrued  or  may  accrue  in  relation  to  any  of  such  taxes,  and  except 
that  the  unexpended  balance  of  any  appropriation  heretofore  made 


TEXT  OF   1916    LAW   AS   AMENDED  587 

and  now  available  for  the  administration  o£  such  section  or  any 
provision  thereof  shall  be  available  for  the  administration  of  this 
title  or  the  corresponding  provision  thereof. 

Sec.  25.  That  income  on  which  has  been  assessed  the  tax  im- 
posed by  Section  II  of  the  Act  entitled  "An  Act  to  reduce  tariff 
duties  and  to  provide  revenue  for  the  Government,  and  for  other 
purposes,  "-approved  October  third,  nineteen  hundred  and  thirteen, 
shall  not  bo  considered  as  income  within  the  meaning  of  this  title :' 
Provided,  That  this  section  shall  not  conflict  with  that  portion  of 
section  ten,  of  this  title,  under  which  a  taxpayer  has  fixed  its  own 
fiscal  year. 

Sec.  26.  Every  corporation,  joint-stock  company  or  associa- 
tion, or  insurance  company  subject  to  the  tax  herein  imposed, 
when  required  by  the  Commissioner  of  Internal  Revenue,  shall 
render  a  correct  return,  duly  verified  under  oath,  of  its  payments 
of  dividends,  whether  made  in  cash  or  its  equivalent  or  in  stock, 
including  the  names  and  addresses'  of  stockholders  and  the  number 
of  shares  owned  by  each,  and  the  tax  years  and  the  applicable 
amounts  in  which  siwh  dividends  were  earned,  in  such  form  and 
manner  as  may  be  prescribed  by  the  Commissioner  of  Internal 
Revenue,  with  the  approval  of  the  Secretary  of  the  Treasury. 

Sec.  27.  That  every  person,  corporation,  partnership,  or  asso- 
ciation, doing  business  as  a  broker  on  any  exchange  or  board  of 
trade  or  other  similar  place  of  business  shall,  when  required  by 
the  Commissioner  of  Internal  Bevenue,  render  a  correct  return  duly 
verified  under  oath,  under  such  rules  and  regulations  as  the  Com- 
missioner of  Internal  Bevenue,  with  the  approval  of  the  Secretary 
nf  the  Treasury,  may  prescribe,  showing  the  names  of  customers 
for  wliom  such  person,  corporation,  partnership,  or  association  heut 
iransaeied  any  business,  with  such  details  as  to  the  profits,  losses, 
or  other  information  which  the  commissioner  may  require,  as  to 
each  of  such  customers,  as  will  cTiable  the  Commissioner  of  Internal 
Bevenue  to  determine  whether  all  income  teue  due  on  profits  or 
gains  of  such  customers  has  been  paid. 

Sec.  28.  That  all  persons,  corporations,  partnerships,  associa- 
tions, and  insurance  companies,  in  whatever  capacity  acting,  in- 
cluding lessee.9  or  mortgagors  of  real  or  personcJ,  property,  trustees 
acting  in  any  trust  capacity,  executors,  administrators,  receivers, 
conservators,  and  employers,  making  payment  to  another  person, 
corporation,  ixirtnership,  association,  or  insurance  company,  of 
interest,  rent,  salaries,  wages,  premiums,  annuities,  compensation. 


588  APPENDIX 

remu7ieration,  emolumenis,  ar  other  fixed  or  determinable  gains, 
profits,  and  income  {other  tlian  paym^ents  described  in  sections 
twenty-six  and  twenty-seven) ,  of  $800  or  more  in  any  taxable  year, 
or,  in  the  case  of  such  payments  made  by  the  United  States,  the 
officers  or  employees  of  tlw  United  States  ha/ving  information  as 
to  such  payments  and  required  to  make  returns  in  regard  thereto 
by  the  regulations  iicreinaftcr  provided  for,  are  Jiereby  authorized 
-and  required  to  render  a  true  and  accurate  return  to  the  Commis- 
sioner of  Internal  Revenue,  under  such  rules  and  regulations  and 
in  such  form  and  manner  as  may  be  prescribed  by  him,  with  the 
approval  of  the  Secretary  of  the  Treasury,  setting  forth  the 
annaunt  of  such  gains,  profits,  and  income,  and  the  name  and 
address  of  the  recipient  of  such  payment:  Provided,  That  such 
returns  shall  be  required,  regardless  of  amounts,  in  the  case  of 
payments  of  interest  upon  bonds  and  mortgages  or  deeds  of  trust 
or  other  similar  obligations  of  corporations,  joint-stocTc  companies, 
associations,  and  insurance  companies,  and  in  the  case  of  collections 
of  items  {not  payable  in  the  United  States)  of  interest  upon  the 
bonds  of  foreign  countries  and  interest  from  the  bonds  and  divi- 
dends from  the  stock  of  foreign  corporations  by  persons,  corpora- 
tions, partnerships,  or  associations,  undertaking  as  a  matter  of 
business  or  for  profit  the  coll-ection  of  foreign  payments  of  such 
interest  or  dividends  by  mea/ns  of  coupons,  cliecks,  or  bills  of 
exchange.  When  necessary  to  make  effective  tlie  provisions  of  this 
section  the  luvme  and  address  of  the  recipient  of  income  shall  be 
furnished  upon  demand  of  the  person,  corporation,  partnership, 
association,  or  insurance  company  paying  the  income. 

The  provisions  of  this  section  shall  apply  to  the  calendar  year 
nineteen  hundred  and  seventeen  and  each  calendar  year  thereafter, 
but  shall  not  apply  to  the  payment  of  interest  on  obligations  of 
the  United  States. 

Sec.  29.  That  in  assessiti^  income  tax  the  net  income  em- 
braced i7i  the  return  shall  also  be  credited  with  the  amount  of  any 
excess  profits  tax  imposed  by  Act  of  Congress  and  assessed  for  the 
same  calendar  or  fiscal  year  upon  the  taxpayer,  and,  in  the  case  of 
a  member  of  a  partnership,  with  his  proportionate  share  of  such ' 
excess  profits  tax  imposed  upon  the  partnership. 

Sec.  30.  That  nothing  in  section  II  of  tlw  Act  approved 
October  third,  nineteen  hundred  and  thirteen,  entitled  "An  Act 
to  reduce  tariff  duties  and  to  provide  revenue  for  the  Government, 
and  for  other  purposes,"  or  in  this  title,  shall  be  construed  as 


TEXT   OF    1916    LAW    AS   AMENDED  589 

tiirinfl  the  income  of  foreign  (lovemments  received  from  invest- 
ments in  the  United  States  in  stocks,  bonds,  or  other  domestic 
securities,  owned  by  such  foreign  governments,  or  from  ititerest  on 
deposits  in  banks  in  the  United  States  of  moneys  belonging  to 
foreign  governments. 

Sec.  31.  (a)  That  tlw  term  "'■dividends"  as  used  in  this  title 
s/uiU  be  held  to  mean  any  dustribution  made  or  ordered  to  be  made 
by  a  corporation,  joint-stock  company,  association,  or  insurance 
company,  out  of  its  earnings  or  profits  accrued  since  March  first, 
nineteen  hundred  and  thirteen,  and  payable  to  its  shareholders, 
whether  in  cash  or  in  stock  of  the  corporation,  joint-stock  com- 
pany, association,  or  insurance  company,  which  stock  dividend 
shall  be  considered  incovM,  to  the  amount  of  the  earnings  or 
profits  so  distributed. 

(6)  Any  distribution  nuuie  to  the  shareholders  or  members  of 
a  corporation,  joint-stock  company,  or  association,  or  insurance 
company,  in  the  year  nineteen  hundred  and  seventeen,  or  subse- 
quent tax  years,  shall  be  deemed  to  have  been  made  from  the  most 
recently  accumulated  undivided  profits  or  surplus,  and  shall  con- 
stitute a  part  of  the  annual  income  of  the  distributee  for  the  year 
in  which  'received,  and  shall  be  taxed  to  the  distributee  at  the  rates 
prescribed  by  law  for  the  years  in  which  such  profits  or  surplus 
were  accumulated  by  the  corporation,  joint-stock  company,  asso- 
ciation, or  insurance  company,  but  nothing  herein  shall  be  con- 
strued as  taxing  any  earnings  or  profits  accrued  prior  to  March 
first,  nineteen  hundred  and  thirteen,  but  such  earnings  or  profits 
may  be  distributed  in  stock  dividends  or  otherwise,  exempt  from 
the  tax,  after  the  distributioit  of  earnings  and  profits  accrued  since 
March  first,  nineteen  hundred  and  thirteen,  has  been  made.  This 
Mtbdivision  shall  not  apply  to  any  distribution  made  prior  to 
Aug%ist  sixth,  nineteen  hundred  and  seventeen,  out  of  earnings  or 
profits  accrued  prior  to  March  first,  nineteen  hundred  and  thirteen. 

Sec.  32.  That  premiums  paid  on  life  insuratice  policies  cover- 
ing the  lives  of  officers,  employees,  or  those  financially  interested  in 
any  trade  or  business  conducted  by  an  individual,  partnership, 
corporation,  joint-stock  company  or  association,  or  insurance  com- 
pany, shall  not  be  deducted  in  computing  the  net  income  of  such 
individual,  corporation,  joint-stock  company  or  association,  or  in- 
surance company,  or  in  computing  the  profits  of  such  partnership 
for  the  purposes  of  subdivision  (e)  of  section  nine. 

See.  1212.     That  any  amount  heretofore  u^thkeld  by  any  with- 


590  APPENDIX 

holding  agent  as  required  by  Title  I  of  such  Act  of  September 
eighth,  mneieen  hundred  and  sixteen,  on  account  of  the  tax  im- 
posed upon  the  income  of  any  individual,  a  dtisen  or  resident  of 
the  United  S,tates,  for  the  calendar  year  nineteen  hundred  and 
seventeen,  except  in  the  cases  covered  by  subdivision  (c)  of  section 
nine  of  such  Act,  as  amended  by  this  Act,  shall  be  released  a)id 
paid  over  to  such  individual,  and  the  entire  tax  upon  the  income 
of  such  individual  for  such  year  shall  be  assessed  and  collected  in 
the  manner  prescribed  by  such  Act  a,s  amended  by  this  Act. 


TEXT  OF  1917  LAW 

Act  or  October  3,  1917 
TITLE  I.— WAR  INCOME   TAX 

Section  1.  That  in  addition  to  the  normal  tax  imposed  by 
subdivision  (a)  of  section  one  of  the  Act  entitled  * '  An  Act  to 
increase  the  revenue,  and  for  other  purposes,"  approved  Septem- 
ber eighth,  nineteen  hundred  and  sixteen,  there  shall  be  levied, 
assessed,  collected,  and  paid  a  like  normal  tax  of  two  per  centum 
upon  the  income  of  every  individual,  a  citizen  or  resident  of  the 
United  States,  received  in  the  calendar  year  nineteen  hundred  and 
seventeen  and  every  calendar  year  thereafter. 

Sec.  2.  That  in  addition  to  the  additional  tax  imposed  by 
subdivision  (fe)  of  section  one  of  such  Act  of  September  eighth, 
nineteen  hundred  and  sixteen,  therp  shall  be  levied,  assessed,  col- 
lected, and  paid  a  like  additional  tax  upon  the  income  of  every 
■  individual  received  in  the  calendar  year  nineteen  hundred  and 
seventeen  and  every  calendar  year  thereafter,  as  follows: 

One  per  centum  per  annum  upon  the  amount  by  which  the  total 
net  income  exceeds  $5,000  and  does  not  exceed  $7,500; 

Two  per  centum  per  annum  upon  the  amount  by  which  the 
total 'net  income  exceeds  $7,500  and  does  not  exceed  $10,000; 

Three  per  centum  per  annum  upon  tlie  amount  by  which  the 
total  net  income  exceeds  $10,000  and  does  not  exceed  $12,500;    ' 

Four  per  centum  per  annum  upon  the  amount  by  which  the 
total  net  income  exceeds  $12,500  and  does  not  exceed  $15,000; 

Five  per  centum  per  annum  upon  the  amount  by  which  the 
total  net  income  exceeds  $15,000  and  does  not  exceed  $20,000; 

Seven  per  centum  per  annum  upon  the  amount  by  which  the 
total  net  income  exceeds  $20,000  and  does  not  exceed  $40,000; 

Ten  per  centum  |>er  annum  upon  the  amoujit  by  which  the 
total  net  income  exceeds  $40,000  and  does  not  exceed  $60,000; 

591 


592  APPENDIX 

Fourteen  per  centum  per  annum  upon  the  amount  by  which  the 
total  net  income  exceeds  $60,000  and  does  not  exceed  $80,000; 

Eighteen  per  centum  per  annum  upon  the  amount  by  which  the 
total  net  income  exceeds  $80,000  and  does  not  exceed  $100,000 ; 

Twenty-two  per  centum  per  annum  upon  the  amount  by  which 
the  total  net  income  exceeds  $100,000  and  does  not  exceed 
$150,000; 

Twenty-five  per  centum  per  anniun  upon  the  amount  by  which 
the  total  net  income  exceeds  $150,000  and  does  not  exceed 
$200,000; 

Thirty  per  centum  per  annum  upon  the  amount  by  which  the 
total  net  income  exceeds  $200,000  and  does  not  exceed  $250,000; 

Thirty-four  per  centum  per  annirni  upon  the  amount  by  which 
the  total  net  income  exceeds  $250,000  and  does  not  exceed 
$300,000; 

Thirty-seven  per  centum  per  annum  upon  the  amount  by  which 
the  total  net  income  exceeds  $300,000  and  does  not  exceed 
$500,000; 

.Forty  per  centum  per  annum  upon  the  amount  by  which  the 
total  net  income  exceeds  $500,000  and  does  not  exceed  $750,000; 

Forty -five  per  centum  per  annum  upon  the  amount  by  which  the 
total  net  income  exceeds  $750,000  and  does  not  exceed  $1,000,000; 

Fifty  per  centum  per  annum  upon  the  amount  by  which  the 
total  net  income  exceeds  $1,000,000. 

Sec.  3.  That  the  taxes  imposed  by  sections  one  and  two  of 
this  Act  shall  be  computed,  levied,  assessed,  collected,  and  paid 
upon  the  same  basis  and  in  the  same  manner  as  the  similar  taxes 
imposed  by  section  one  of  such  Act  of  September  eighth,  nineteeu 
liundred  and  sixteen,  except  that  in  the  case  of  the  tax  imposed 
by  section  one  of  this  Act  (a)  the  exemptions  of  $3,000  and  $4,000 
provided  in  section  seven  of  such  Act  of  September  eighth,  nine- 
teen hundred  and  sixteen,  as  amended  by  this  Act,  shall  be, 
respectively,  $1,000  and  $2,000,  and  (b)  the  returns  required  under 
subdivisions  (b)  and  (c)  of  section  eight  of  such  Act,  as  amended 
by  this  Act,  shall  be  required  in  the  case  of  net  incomes  of  $1,000 
or  over,  in  the  case  of  unmarried  persons,  and  $2,000  or  over  in 
the  case  of  married  persons,  instead  of  $3,000  or  over,  as  therein 
provided,  and  (c)  the  provisions  of  subdivision  (r)  of  section  nim- 
of  such  Act,  as  amended  by  this  Act,  requiring  the  normal  tax  of 
individuals  on  income  derived  from  interest  to  be  deducted  and 
withheld  at  the  source  of  the  income  shall  not  apply  to  the  new 


TEXT  or  1917  LAW  593 

two  per  centum  normal  tax  prescribed  in  section  one  of  this  Act 
until  on  and  after  January  first,  nineteen  hundred  and  eighteen, 
and  thereafter  only  one  two  per  centum  normal  tax  shall  be  de- 
ducted and  withheld  at  the  source  under  the  provisions  of  such 
subdivision  (c),  and  any  further  normal  tax  for  which  the  recipient 
of  such  income  is  liable  under  this  Act  or  such  Act  of  September 
eighth,  nineteen  hundred  and  sixteen,  as  amended  by  this  Act,  shall 
be  paid  by  such  recipient. 

Sec.  4.  That  in  addition  to  the  tax  imposed  by  subdivision  (a) 
of  section  ten  of  such  Act  of  September  eighth,  nineteen  hundred 
and  sixteen,  as  amended  by  this  Act,  there  shall  be  levied,  assessed, 
collected,  and  paid  a  like  tax  of  four  per  centum  upon  the  income 
received  in  the  calendar  year  nineteen  hundred  and  seventeen  and 
every  calendar  year  thereafter,  by  every  corporation,  joint-stock 
company  or  association,  or  insurance  company,  subject  to  the  tax 
imposed  by  that  subdivision  of  that  section,  except  that  if  it  has 
fixed  its  own  fiscal  year,  the  tax  imposed  by  this  section  for  the 
fiscal  year  ending  during  the  calendar  year  nineteen  hundred  and 
seventeen  shall  be  levied,  assesse*!,  collected,  and  paid  only  on  that 
proportion  of  its  int-oini'  for  such  fiscal  year  which  the  period 
between  January  first,  nineteen  hundred  and  beventeen,  and  the 
end"  of  such  fiscal  year  bears  to  the  whole  of  such  fiscal  year. 

The  tax  imposed  by  this  section  shall  be  computed,  levied, 
assessed,  collected,  and  paid  upon  the  same  incomes  and  in  {he 
same  manner  as  the  tax  impose<l  by  subdivision  (a)  of  section  ten 
of  such  Act  of  September  eighth,  nineteen  hundred  and  sixteen, 
as  amended  by  this  Act>  except  that  for  the  purpose  of  the  tax 
imposed  by  this  section  the  income  embracetl  in  a  return  of  a 
corporation,  joint-stock  company  or  association,  or  insurance  com- 
pany, shall  be  credited  with  the  an^unt  received  as  dividends  upon 
the  stock  or  from  the  net  earnings  of  any  other  corporation,  joint- 
stock  company  or  association,  or  insurance  company,  which  is 
taxable  upon  its  net  income  as  provided  in  this  title. 

Sec.  5.  That  the  provisions  of  this  title  shall  not  extend  to 
Porto  Rico  or  the  Philippine  Islands,  and  the  Porto  Rican  or 
Philippine  Legislature  shall  have  power  by  due  enactment  to 
amend,  alter,  modify,  or  rejieal  the  income  tux  law.s  in  force  in 
I'orto  Rico  or  the  Philippine  Islands,  respectively. 


F.  I.  Tax.— 38. 


594  APPENDIX 

ADMINISTEATIVE    PEOVISIONS    OF    THE    ACT 
OF  OCTOBER  3,  1917  i 

Sec.  1009.  That  the  Secretary  of  the  Treasury,  under  rules  and 
regulations  prescribed  by  him,  shall  permit  taxpayers  liable  to 
income  and  excess  profits  taxes  to  make  payments  in  advance  in 
installments  or  in  whole  of  an  amount  not  in  excess  of  the  esti- 
mated taxes  which  will  be  due  from  them,  and  upon  determination 
of  the  taxes  actually  due  any  amount  paid  in  excess  shall  be 
refunded  as  taxes  erroneously  collected:  Provided,  That  when 
payment  is  made  in  installments  at  least  one-fourth  of  such  esti- 
mated tax  shall  be  paid  before  the  expiration  of  thirty  days  after 
the  close  of  the  taxable  year,  at  least  an  additional  one-fourth 
within  two  months  after  the  close  of  the  taxable  year,  at  least  an 
additional  one-fourth  within  four  months  after  the  close  of  the 
taxable  year,  and  the  remainder  of  the  tax  due  on  or  before  the 
time  now  fixed  by  law  for  such  payment :  Provided  further,  That 
the  Secretary  of  the  Treasury,  under  rules  and  regulations  pre- 
scribed by  him,  may  allow  credit  against  such  taxes  so  paid  in 
advance  of  an  amount  not  exceeding  three  per  centum  per  annum 
calculated  upon  the  amount  so  paid  from  the  date  of  such  pay- 
ment to  the  date  now  fixed  by  law  for  such  payment";  but  no  such 
credit  shall  be  allowed  on  payments  in  excess  of  taxes  determined 
to  be  due,  nor  on  payments  made  after  the  expiration  of  four 
and  one-half  months  after  the  close  of  the  taxable  year. 

All  penalties  provided  by  existing  law  for  failure  to  pay  tax 
when  due  are  hereby  made  "applicable  to  any  failure  to  pay  the 
tax  at  the  time  or  times  required  in  this  section. 

See.  1010.  That  under  rules  and  regulations  prescribed  by  the 
Secretary  of  the  Trea,sury,  Collectors  of  Internal  Revenue  may 
receive,  at  par  and  accrued  interest,  certificates  of  indebtedness 
issued  under  section  six  of  the  Act  entitled  "An  Act  to  authorize 
an  issue  of  bonds  to  meet  expenditures  for  the  national  security 
and  defense,  and,  for  the  purpose  of  assisting  in  the  prosecution 
of  the  war,  to  extend  credit  to  foreign  governments,  and  for  other 
purposes,"  approved  April  twenty-fourth,  nineteen  hundred  and 
seventeen,  and  any  subsequent  Act  or  Acts,  and  uncertified  checks 
in  payment  of  income  and  excess  profits  taxes,  during  snoli  tinu- 

1  These  provisions  apply  to  the  1916  Law  and  the  1917  Law. 
They  are  contained  in  Title  X  of  the  Act  of  October  3,  1917.    # 


ADMINISTRATIVE   PROVISION  595 

and  under  such  regulations  as  the  Commissioner  of  Internal 
Revenue,  with  the  approval  of  the  Secretary  of  the  Treasury, 
shall  prescribe;  but  if  a  check  so  received  is  not  paid  by  the  bank 
on  which  it  is  drawn  the  person  by  whom  such  check  ha«  been 
tendered  shall  remain  liable  for  the  payment  of  the  tax  and  for 
all  legal  penalties  and  additions  the  same  as  if  such  check  had 
not  been  tendered. 


TABLE  OF  CASES 


Abrast  Realty  Co.  v.  Maxwell,! 

206  Fed.  333 
Aguirre  'v.  Maxwell,  3  Blatch. 

140,  Fed.  Cas.  No.  101 
Alkan    v.   Bean,   23   Int.   Rev. 

Rec.  351,  Fed.  Cas.  No.  202, 

8  Bliss  83 
Allen  V.  Pullman's  Palace  Car 

Co.,  139  U.  8.  658,  11  S.  Ct. 

682,  35  L.  Ed.  303 
Altheimer  &  Rawlings  Inv.  Co. 

V.    Allen  1    T.    D.    2441    (Not 

yet  officially  reported) 
Ambrosini  v.  U.  S.,  187  U.  S. 

1,  23  8.  Ct.  1,  47  L.  Ed.  49 
Amer.   Net   and   Twine  Co.   v. 

Worthington,  141  U.  8.  468, 

12  8.  Ct.  55,  35  L.  Ed.  821 
Anderson   v.  Forty-two  Broad- 
way   Company,!    239    U.    8. 

69,  69  8.  Ct.   17,  60  L.  Ed. 

152;   reversing  213  Fed.  777 

and  209  Fed.  991 
Anderson    v.    Morris    &    Essex 

Railroad   Co.,1   216   Fed.   83, 

132  C.  C.  A.  327 
Railey  v.  New  York  C.  &  H.  R. 

Co.,    106   U.   8.   109,    1    8up. 

Ct.  62,  27  L.  Ed.  81 
Bailey    v.    Railroad    Company, 

22  Wall.  604,  22  L.  Ed.  840 
Baldwin    Loco.    Works    v.    Me- 

Coach.l   221    Fed.    59,   C.   C. 

A,;  affirming  215  Fed.  927 
Baltimore  v.  Baltimore   R.  R., 

10  Wall.  543,  19  L,  Ed.  1043 
Hank  of  Greencastle  v.  V.  8., 

15  Ct.  Cls.  225 
Bartels    v.    Redfield,    27    Fed. 

286 


Benziger    v.    U.    8.,   192    U.   8, 

38,  24  8.  Ct.  189,  48  L.  Ed. 

331 
Billings  v.  United  States,  232 

U.  8.    261,  34   Sup.   Ct.  421, 

58  L.  Ed.  596 
Biwabik  Mining  Co.  v.  U.  S.,1 

242  Fed.  9. 
Boughton  v.  U.  8.,  12  Ct.  Cls. 

330 
Bradv  v.  Anderson,*  240  Fed. 

665 
Brushaber  v.  Union  Pacific  R. 

R.   Co.,2  240   U.  8.   1,  36  8. 

Ct.  236,  60  L.  Ed.  495 
Brvant  &  May,  Ltd.  v.  Scott,! 

226   Fed.    875 
Burrough  v.  Abel,  105  Fed.  366 
Butterick    Co.    v.    U.    8.,«    240 

Fed.  539 
Cambria     Steel     Co.     v.      Mc- 

Coach,!  225  Fed.  278 
Carrick   v.    Lamar,    116   U.   8. 

423,  6  8.  Ct.  424,  29  L.  Ed. 

677 
Catawissa    R.    B.    t.    Phila.    & 
jl^  Reading  Ry.,  255  Pa.  269 
Chapman,  Tn're,  166  U.  8.  661, 

17  S.  Ct.  677,  41  L.  Ed.  1154 
Cheatham   v.    U.   8.,  92   U.   S. 

85,  23  L.  Ed.  561 
Chesebrough    v.   U.  8.,   192   U. 

a.   253,  24  8.  Ct.  262,  48  L. 

Ed.  432 
Chicago,   etc.,    Rv.    v.    Kansas 

Citv  N.  W.  R.'  R.,  75  Kans. 

167',  88  Pac.  1085 
Christie-Street    Comm.    Co.    v. 

U.  8.,  136  Fed.  326,  69  C.  C. 

A.  464 


39« 


598 


TABLE   OF    CASES 


City  of  Phila.   v.  Collector,  5 

Wall  720,  18  L.  Ed.  614 
Cleveland,  etc.,  Ey.  Co.  v.  U. 

S.,1  242  Fed.  18 
Clopton    V.    Phila.    &    Reading 

R.  R.  54  P.  A.  356 
Cohen  v.  Lowe,2  234  Fed.  474 
Collector  v.  Day,  11  Wall.  113, 

20  L.  Ed.  122 
Commercial  Travelers'  Life  & 

Ace.  Ass'n  V.  Rodway,!  235 

Fed.  370 
Commissioners  v.  Buckner,  48 

Fed.  533 
Conant    v.    Kinney,    162    Fed. 

581 
Conn.    Gen.    Life    Ins.    Co.    v. 

Eaton,l  218  Fed.  188. 
Conn.  Mutual  Life  Ins.  Co.  v. 

Eaton,l  218  Fed.  206 
Corning    v.    U.    S.,    34   Ct.    CI. 

271 
Gumming  v.  U.  S.,  22   Ct.   CIs. 

344 
DeBary    v.    Carter,    102    Fed. 

130,  42  C.  C.  A.  209 
DeBary    v.    Dunne,    162    Fed. 

961 
Decatur  v.   Paulding,   14   Pet. 

497,  10  L.  Ed.  559 
De     Ganay    v.     Lederer,8     239 

Fed.  568 
Delaware  R.  R.  Co.  v.  Pretty- 
man,   17  Int.   Rev.   Rec.   99, 

Fed.  Cas.  No.  3767 
Dodge    v.    Brady ,2    240    U.    S. 

123,  30  S.  Ct.  277,  60  L.  Ed. 

560 
Dodge   v.   Osborn,2   240   TJ.    S. 

118,  36  S.  Ct.  275,  60  L.  Ed. 

557 
Doherty  v.  U.  S.,  6  Ct.  CIs.  90 
Dollar  Savings  Bank  v.  U.  S., 

19  Wall.  227,  22  L.  Ed.  80 
Doyle   V.   Mitchell  Bros.   Co.,1 

235  Fed.   686,   149   C.   C.   A. 

106 
Dugan    V.    U.    S.,    34    Ct.    CIs. 

458 
Edison     Electric     Illuminating 

Co.  V.  U.  S.,  38  Ct.  CIs.  208 


Edwards    v.   Keith,2   231    Fed. 

110,  145  C.  C.  A.  298 
Eliot  Nat.  Bank  v.  Gill,l  218 

Fed.   600,   134  C.   C.  A.  358 
Eliot   V.   Freeman,!   220   U.   S. 

178,  31  S.  Ct.  360,  55  L.  Ed. 

424 
Emery,    Bird     Thayer    Realty 

Co.  V.  U.  S.,1  198  Fed.  242 
Equitable   Trust   Co.   v.   West- 
ern Pac.  Ry  Co.  et  al.,2  236 

Fed.  813 
Erie    &    Pittsburgh    R.    R.    v. 

Penn.  R.  R.,  208  Pa.  506,  57 

Atl.  980 
Erskine    v.    Van    Arsdale,    15 

Wall.  75,  21  L.  Ed.  63 
Farrell  v.  U.  S.,  167  Fed.  639 
First    Nat.    Bank    of    Green- 
castle  V.   U.  S.,   15   Ct.   CIs. 

225 
First   Nat.   Bank    of   Jackson, 

Miss.  V.  Mc.  Neel,l  238  Fed. 

559,  151  C.  C.  A.  495 
Flint  V.  Stone-Tracy  Co.,1  220 

U.  S.  107,  31  S.  Ct.  342,  55 

L.  Ed.  389 
Forty-fort  Coal  Co.  v.  Kirken- 

dall,l  233  Fed.  704 
Gauley  Mt.  Coal  Co.  v.  Hays,l 

230   Fed.    110,   144   C.   C.   A. 

408 
Gould  V.  Gould,2  No.  41,  Oct. 

Term,  1917,  U.  S.  Sup.  Ct., 

not  yet  officially  reported. 
Grand  Rapids  &  Ind.   Ry.  Co. 

V.  Doyle,l  T.  D.  2210 
Grav   V.   Darlington,   15  Wall. 

63,  21  L.  Ed.  45 
Grier  v.  Tucker,  150  Fed.  658 
Gulf    Oil   Corp.    V.   Lewellyn,2 

242   Fed.    709;    reversed   by 

Circuit    Court    of    Appeals, 

Lewellyn    v.    Gulf    Oil    Cor- 
poration, T.  D.  2542 
Haight     V.     Railroad     Co.,     6 

Wall.  15,  18  L.  Ed.  818 
Hartranft    v.    Weigmann,    121 

U.  S.  609,  7  S.  Ct.  1240,  30 

L.  Ed.  1012 


TABLE   or   CASES 


599 


Hastings   v.   Herold,  184  Fed. 

759 
Herold  v.  Kahn,  163  Fed.  947, 

86  C.  C.  A.  598 
Herold  v.  Mutual*  Benefit  Life 

Ins.  Co.,1  201  Fed.  918 
Herold    v.    Parkview   Bldg.    & 

Loan  Ass  'n,l  210  Fed.  577 
Hicks    V.   James'   Admx.,    110 

U.  S.  272,  4  8.  Ct.  6,  28  L. 

Ed.  144 
Home    Savings    Bank    v.    Des 

Moines,   205    U.    8.    503,    27 

8up.  Ct.  571,  51  L.  Ed.  901 
Industrial  Trust  Co.  v.  Walsh ,1 

222  Fed.  437 
Insurance    Company    of    North 

America    v.     McCoach,!     218 

Fed.  905 
Jacobs   and    Davies    (Inc.)    v. 

Anderson,!   228  Fed.  505 
Jasper   &   Eastern   By.   Co.   v. 

Walker,!   238   Fed.  533,  151 

C.  C.  A.  469 
Johnson    v.    Herold,    161    Fed. 

593 
Kaufman    v.    U.   8.,   96   U.    8. 

567,   24   L.   Ed.   792,   13   Ct. 

Cls.  562 
Keelev    v.    Sanders,   99   U.    8. 

441,'  25  L.  Ed.  327 
King   v.   U.   S.,  99   U.  S.   229, 

25  L.  Ed.  373 
Kings    County    Sav.    Inst.    v. 

Blair,   116  U.  8.  200,  206,  6 

S.  Ct.  353,  29  L.  Ed.  657 
Kinnev    v.    Conant,    166    Fed. 

720,"  92  C.  C.  A.  410 
Klock  Produce  Co.  v.  Hartson, 

212  Fed.  758 
Knowlton  v.  Moore,  178  U.  8. 

41.  20  8.  Ct.  747,  44  L.  Ed. 

969 
Kohlhamer   v.   Smietanka,   2.39 

Fed.  408 
Laurentide  Co.  Ltd.  v.  T)nrey,l 

231  Fed.  22.T 
I^wellvii    V.    Pittsburgh,    B.    & 

L.  E.  R.  Co.,!  222  Fed.  177, 

137  C.  C.  A.  617 
Little    V.    Bowers.    134    U.    8. 


547,  10  8.  Ct.  620,  33  L.  Ed. 

1016 
Little   Schuylkill,  etc.,   Co.   v. 

Phila.  &  B.  By.  Co.,«  44  Pa. 

Co.  Ct.  Rep.  197 
Lynch    v.    Hornby,«    236    Fed. 

661,  149  C.  C.  A.  657 
Lynch    v.    Turrish,«    236    Fed. 

*653,  149  C.  C.  A.  649 
McCoach  v.  Continental  Pass. 

By.  Co.,!   233  Fed.  976,  147 

C.  C.  A.  650 
McCoach    v.    Ins.    Co.    of    N, 

Am.,!  241  U.  8.  674,  36  Sup. 

Ct.  724,  60  L.  Ed.  1231;  re- 
versing 224  Fed.  657 
McCoach    y.    Mine    Hill,    etc., 

Co.,1  228  U.  8.  295,  33  8.  Ct. 

419,  57  L.  Ed.  842 
McCulloch      v.     Maryland,     4 

Wheat.  316,  4  L.  Ed.  579 
McLain  v.  Penn.  Co.,  108  Fed. 

618,  47  C.  C.A.  529 
Maryland   Casualty   Co.   v.   U. 

8.   (Court  of  Claims),  T.  D. 

2451 
Medburv   v.   U.   8.,   173   U.   8. 

492,  19  8.  Ct.  503,  43  L.  Ed. 

779 
Merck  v.  Treat,  174  Fed.  388, 

98  C.  C.  A.  606 
Merritt  v.  Cameron,  137  U.  8. 

542,  11  a.  Ct.  174,  34  L.  Ed. 

772 
Middlesex     Banking     Co.     v. 

Eaton,!  233   Fed.  87.   147  C. 

C.  A.  157;  affirming  221  Fed. 

86 
Miller    v.    Snake    River,    etc., 

Co.,!  223  Fed.  946,  139  C.  C. 

A.  426 
Mine    Hill,    etc.,    Co.    v.    Mc- 
Coach,! 192  Fed.  670 
Mitchell    V.    Dovle.!    225    Fed. 

437 
Moore  v.   Stewarts,  etr.,  Ltd., 

8  Fra.««er  1129 
Mutual  Benefit  v.  Herold,!  201 

Fed.  918,  120  C.  C.  A.  256: 

affirming  198  Fed.  199 
Nat.  Bank  of  Comm.  v.  Allen,! 


600 


TABLE  OP   CASES 


223  Fed.  472,  139  C.   C.  A. 
20;  affirming  211  Fed.  743 

New  Orleans   v.   Stemple,   175 

U.  S.  309,  20  S.  Ct.  110,  44 

L.  Ed.  174 
New  York  C.  &  H.  E.  v.  Gill,l 

219  Fed.   184,  134  C.  C.  A. 

558 
New  York  Mail,  etc.,  v.  Ander- 
son,! 234  Fed.  590,  148  C.  C. 

A.  356 
Nichols  V.  IT.  S.,  7  Wall.  122,  19 

L.  Ed.  125 
Nixon  V.  U.  S.,  18  Ct.  Cls.  448 
North  Pa.  E.  E.  Co.  v.  P.  &  E. 

Ey.  Co.,2  249  Pa.  326,  95  Atl. 

100 
Northern  Central  E.  E.  Co.  v. 

Jackson,  7  Wall.  262,  19  L. 

Edf  88 
Northern    Trust   Co.    v.   Buck, 

263  111.  222,  104  N.  E.  1114 
Northern    Trust    Co.    v.    Mc- 

Coach,!  215  Fed.  991 
Nye    V.    Washburn,    125    Fed. 

818 
Osborne,  Matter  of;  209  A.  D. 

(N.  Y.)  450 
Osterberg  v.  Union  Tr.  Co..  93 

U.  S.  424,  23  L.  Ed.  964 
Pacific  Bldg.  &  Loan  Ass'n.  v. 

Hartson,!  201  Fed.  1011 
Parkview  Bldg.,  etc.,   v.  Her- 

old,l  210  Fed.  577,  127  C.  C. 

A.  213 
Patton    V.    Brady,    Executrix, 

184  U.  S.  608,  22  S.  Cf.  493, 

46  L.  Ed,  713 
Peck  V.  Lowe,2  234  Fed.  125 
Penn.  Steel  Co.  v.  N.  Y.  C.  Ey. 

Co.,1  176  Fed.  471,  193  Fed. 

286,  198  Fed.  774,  117  C.  C. 

A.  556 
People  V.  Davenport,  30  Hun. 

177 
Pettibone    v.    Smith,    150    Pa. 

118,   24  A.  693 
Phila.   H.    &   P.   E.   E.    Co.   v. 

Lederer,!  242  Fed.  492 
Phila.    Traction    v.    McCoach,! 

224  Fed.  800 


Pollock  V  Farmers  L.  &  T.  Co., 

157  U.  S.  429,  15  S.  Ct.  673, 

39  L.  Ed.  759;  158  U.  S.  601, 

15  S.  Ct.  912,  39  L.  Ed.  1108 
Pub.  Serv.  Electric  Co.  et  al. 

V.    Herold,!    227    Fed.    486, 

229  Fed.  902,  144  C.  C.  A.  184 
Pub.  Serv.  Gas  Co.  v.  Herold,! 

227  Fed.  496;  229  Fed.  902, 

144  C.  C.  A.  184 
Pub.  Serv.  Ey.  Co.  v.  Herold,! 

219  Fed.  301;  227  Fed.  490; 

229   Fed.   902,   144   C.   C.   A. 

184 
Pub.  Serv.  Ey.  Co.  v.  Moffett,! 

227  Fed.  494;   229  Fed.  902, 

144  C.  C.  A.  184 
Eailroad    Co.    v.    Commission- 
ers, 98  U.  S.  541,  25  L.  Ed. 

196 
Eailroad     Co.     v.     Howard,     7 

Wall.  392 
Eeal  Estate   Sav.  Bank  v.  U. 

S.,  16  Ct.  Cls.  335;  104  U.  S. 

728,  26  L.  Ed.  908 
Eedfield  v.  Iron  Co.,  110  U.  S. 

174,  3  Sup.  Ct.  570,  28  L:  Ed. 

109 
Eensselaer,  etc.,  Co.  v.  Irwin,2 

239  Fed.  739 
Eidgway  v.  U.  S.,   18  Ct.  Cls. 

707 
Eio  Grande  J.  E.  Co.  v.  U.  S.,1 

51  Ct.  Cls.  274 
Eoberts  v.  Anderson,!  226  Fed. 

7,  141  C.  C.  A.  121 
Eoberts    v.    Lowe,!    236    Fed. 

604 
St.     Paul,     etc.,     Ey.     Co.     v. 

Phelps,  137  U.  S.  528,  US. 

Ct.  168,  34  L.  Ed.  767 
San    Francisco    Sav.    Soc.    v. 

Cary,  2  Sawy.  393 
Sargent     Land     Co.     v.     Von 

Baumbach,!  207  Fed.  423 
Schwarzchild    v.    Eucker,    143 

Fed.  656 
Snvder    v.    Marks,    109    U.    S. 

189,  3  S.  Ct.  157,  27  L.  Ed. 

901 


TABLE   OP   CASES 


601 


South    Carolina   v.    U.   S.,   199 

U.  8.  437,  23  S.  Ct.  110,  50 

L.  Ed.  261 
Southern  Pacific  Co.  v.  Lowe,S 

238  Fed.  847 
Spreckels   Sug.  R.  Co,   v.  Mc- 

Clain,  192   U.  S.  397,  24  S. 

Ct.  376,  48  L.  Ed.  496 
Stanton  v.  Baltic  Mining  Co.,8 

240  U.  S.  103,  36  S.  Ct.  278, 

60  L.  Ed.  546 
State  R.  R.  Tax  Cases,  92  U.  S. 

575,  23  L.  Ed.  663 
State  V.  Evans,  99  Minn.  220 
Stewart  v.  Barnes,  153  U.  S. 

456,  14  S.  Ct.  849,  38  L.  Ed. 

781 
Stockdale  v.  Ins.  Co.,  20  Wall. 

323,  22  L.  Ed.  348 
Stotesburv  v.  U.  S.,  146  U.  S. 

196,  13 'S.  Ct.,1  36  L.  Ed.  940 
Stratton's  Independence,  Ltd., 

V.  Howbert.l  231  U.  S.  399, 

34  S.  Ct.  136,  58  L.  Ed.  285 
Strauss  v.  Abrast  Realty  Co.,1 

200  Fed.  327 
Strouse,  In  re,  1  Sawy.  605 
Suter    V.    Jordan-Marsh    Co.,8 

113  N.  E.  .580 
Swift  Co.  V.  tJ.  S.,  105  U.  S. 

691,  26  L.  Ed.  1108 
Towne  v.  Eisner,*  242  Fed.  702 
Traction  Co.'s  v.  Coll.  of  Int. 

Rev.,1  223  Fed.  984,  139  C. 

C.  A.  360 
Treat  v.  Farmer's  Loan  &  T. 

Co.,  185  Fed.  760,  108  C.  C. 

A.  98 
Tvee  Realty  Co.  v.  Anderson,* 

240  U.  S.  115,  30  S.  Ct.  281, 

60  L.  Ed.  554 
Union  HoUvw  'd  Co.  v.  Carter,! 

238  Fed.'  329,  151  C.  C.  A. 

345 
Urquhart     v.     Marion     Hotel 

Co.,8  194  S.  W.  1 
T*.    8.    V.    Acorn    Roofing   Co.,1 

204  Fed.  157 
V.  S.  V.   Alexander,  110  U.  8. 

325.  4  S.  Ct.  99,  28  L.  Ed. 

166 


U.  8.  V.  Alger,  152  U.  S.  384, 

14  8.  Ct.  635,  38  L.  Ed.  488 
U.  8.  V.  Baltimore  &  Ohio  R.  R., 

17  Wall.  322 
U.  8.  V.  Bayard,  127  U.  8.  251, 

8  Sup.  Ct.   1156,  32  L.  Ed. 

159 
U.  8.  V.  Black,  128  U.  8.  40,  9 

8.  Ct.  12,  32  L.  Ed.  354 
U.  8.  V.  Chouteau,  102   U.  8. 

603,  26  L.  Ed.  246 
U.  8.  V.  Curry,  et  al.,  201  Fed, 

371 
IJ.    8.   V.   Distilled   Spirits,    17 

Int.  Rev.  Rec.  86,  10  Blatch. 

428 
U.  S.  V.  Distillery,  21  Int.  Rev. 

Rec.  366 
U.  8.  V.  Emery,  etc.,1  237  U.  S. 

28,  25  8.  Ct.  499,  59  L.  Ed. 

825 
IT.   8.   V.   Erie   R,  R.   Co.,  106 

U.  S.  327,  1  S.  Ct.  223,  27  L. 

Ed.  151 
U.  S.  V.  Gen.  Insp.  &  Loading 

Co.,1  192  Fed.  223;  204  Fed. 

657 
V.  8.  V.  Graham,  110  U.  8.  219, 

3  S.  Ct.  582,  28  L.  Ed.  126 
U.  8.  V.  Grand  Rap.  &  Ind.  Ry, 

Co,,l  239  Fed.  153 
U.  8.  V,  Guest,  143  Fed,  456, 

74  C.  C.  A.  590 
U.  8.  V.  Guggenheim  Exp.  Co.,1 

238  Fed.  231 
U.  8.  V.  Hill,  120  U.  8.  169,  7 

8.  Ct.  510,  .30  L.  Ed.  627 
U.  8.  V.  Hodson,  14  Int.  Rev. 

Rec.  100 
U,  8.   V.  Little  Miami  Co.,   1 

Fed.  700;  108  U.  8.  277,  2  S. 

Ct,  627,  27  L.  Ed.  724 
U.  8.  V,  McKec,  11  Ct.  Cls.  54; 

91  U.  S.  442,  23  L.  Ed.  326 
U.  8.  V.  Military  Const.  Co.,1 

204  Fed.  153 
U.  8.  V.  Minn.  Threshing  Ma- 
chine Co..l  229  Fed.  1019 
U.  8.  V.  N.  Y.  &  Cuba  Co.,  200 

U.  8,  488,  26  8,  Ct,  327,  50 

L,  E<1.  569 


602 


TABLE   OP    CASES 


U.  S.  V.  Nipissing  Mines  Co.,1 
202  Fed.  803;  206  Fed.  431 

U.  S.  V.  Pacific  K.  R.,  1  Fed.  97 

U.  S.  V.  Railroad  Co.,  17  Wall. 
322,  21  L.  Ed.  597 

U.  S.  V.  Real  Est.  Sav.  Bank, 
104  U.  S.  728,  26  L.  Ed.  908 

U.  S.  V.  Schillinger,  14  Blatch. 

71,  Fed.  Cas.  No.  16228 

U.  S.  V.  Snyder,  149  U.  S.  210, 

13  S.  Ct.  846,  37  L.  Ed.  705 
U.  S.  V.  Stowell,  133  U.  S.  1, 

10  S.  Ct.  244,  33  L.  Ed.  555 
U.  S.  V.  Tanner,  147  U.  S.  661, 

13  S.  Ct.  436,  37  L.  Ed.  321 
U.  S.  V.  Union  Pacific  R.   R. 

Co.,  11  Ct.  Cls.  1;  91  U.  S. 

72,  23  L.  Ed.  224 

U.  S.  V.  Watts,  1   Bond.  580, 

Fed.  Cas.  No.  16653 
U.  S.  V.  Wigglesworth,  2  Story 

369 


U.  S.  V.  Wright,  11  Wall.  648, 

20  L.  Ed.  188 
Van  Beil  v.  Brogan,2  23  D.  R. 

(Pa.)    1055 
Von     Baumbach     v.     Sargent 

Land  Co,,l  242  U.  S.  503,  37 

S.  Ct.  201 
Weaver    v.    Ewers,    195    Fed. 

247,  115  C.  C.  A.  219 
White  V.  Arthur,  10  Fed.  80, 

20  Blatchf.  237 
Wilkes-Barre,   etc.,   v.   Davis,l 

214  Fed.  511 
Woolner   v.   U.   S.,   13   Ct.  Cls. 

355 
Wright  V.  Blakeslee,  101  U.  S. 

174,  25  L.  Ed.  1048 
Zonne     v.     Minn.     Syndicate,! 

220  U.  S.  187,  31  S.  Ct.  .361, 

55  L.  Ed.  428 


1 1909  Law. 
2  1913  Law. 


INDEX 


ABATEMENT  OF  TAX  ASSESSED, 
general  statement,  14. 
procedure  in  claiming,  439. 
rejection  of  claims,  effect  of,  438. 

ABSENTEES, 

returns  may  be  made  by  agents  for,  26. 

ACCIDENT  INSURANCE,  280. 

ACCOUNTING  SYSTEM,  209, 
reporting  on  basis  of,  227. 
required  by  state  or  municipal  authorities,  227. 

ACCOUNTS  ON  BASIS  OF  ACCRUALS,  227. 

ACCOUNTS  PAYABLE,  307. 

ACCOUNTS  RECEIVABLE,  238. 

income  for  year  created,  when,  224. 
partnership,  profits  of,  111. 

ACCRUALS  OF  FIXED  CHARGES,  299. 

ACCRUED  BUT  UNPAID  INTEREST,  208.  _ 

ACCRUED  CHARGES,  DEDUCTED  WHEN,  228. 

ACCRUED  DEDUCTIONS,  298. 

ACCRUED  INTEREST  ON  BONDS,  INCOME  TO  SELLER,  259. 

ACXJRUING  AND  ACCRUED  INCOME,  200. 
reporting  on  basis  of,  207. 

ACCUMULATION  OP  INCOME  IN  TRUST,  88. 

ACTORS,  DEPRECIATION  ON  COSTUMES  OF,  348. 

ACTUAL  DEDUCTIONS  ALLOWED,  297. 

W.i 


604  INDEX 

ACTUAL  INCOME   TAXABLE,  206. 

ACTUAL  RECEIPTS,  207. 

ADDITIONAL   ASSESSMENT,  412. 
abatement  of,  436. 
amended  returns  for,  391. 
corporations,  391. 
notice  of,  391. 
refund  of,  436. 

ADDITIONAL  TAX,  14. 

ADDITIONAL  NORMAL  TAX,  15. 

not  imposed  on  non-resident  aliens,  15. 

ADDITIONAL  SUPERTAX,  16. 

ADDITIONS  AND  BETTERMENTS, 

are  capital  investments,  301.  ' 

depreciation  on,  301. 

ADMINISTRATION  OF  LAWS,  3. 

ADMINISTRATORS, 
are  fiduciaries,  75. 
commissions  of,  81. 
duties  of,  77. 

income  received  by,  during  settlement  of  estate,  86. 
how  reported,  87. 

ADVANCE  PAYMENT  OF  TAX,  404. 

ADVERSE  JUDGMENT,  LOSS  BY,  344. 

AGENTS, 

fiduciary  agent  for  beneficiary,  when,  84. 
foreign  corporations,  appointed  by,  178. 
for  non-resident  aliens,  26. 
for  non-residents,  59. 
may  make  returns  for  principals,  26. 
partnership,  non-resident,  of,  121. 
receipt  by,  is  receipt  by  principal,  224. 
returns  filed  by,  384. 

AGRICULTURAL   ORGANIZATIONS,   WHEN   EXEMPT,    195. 

ALIEN  CORPORATIONS,  180. 

ALIEN  PARTNERSHIPS,   117. 
see  Partnerships. 


INDEX  ,  605 

ALIENS   RESIDING    IN   THE    UNITED   STATES,   2;i. 

ALIMONY  NOT  INCX)ME,  280. 

ALTERATIONS,  COST  OF,  310. 

AMENDED  RETURNS,  391. 
on  second  assessment,  413. 

ANNUAL  ALLOWANCE  FOR  DEPRECIATION,  :{55. 

ANNUAL  LIST  RETURNS,  480. 

ANNUAL  RETURN,  382. 
list  returns,  480. 
of  information  at  source,  454. 
see  Return  of  Annual  Net  Income. 

ANNUITIES,  INCOME  FROM,  289. 

ANTICIPATED  LOSSES  NOT  DEDUCTIBLE,  333. 
profits  not  taxable,  207. 

APARTMENT  HOUSES,  DEPRECIATION  ON,  355. 

ARMY,  RETURNS   SIGNED  BY  PERSONS  IN,  389. 

ASSESSMENT  AND  PAYMENT  OF  TAX, 
additional  assessment,  412. 
advance  payment,  404. 
cannot  be  restrained,  399. 
delinquent  taxes,  interest  on,  416. 
distraint,  419. 
duress,  409. 
general  statement,  398. 
lien,  417. 

manner  of  payment,  405. 
notice  and  demand   for  tax,  401. 
notice  of  assessment,  401. 
payment  under  protest,  407. 
receipt  for,  412. 
second  assessment,  412. 
second  notice  and  demand,  403. 
suit  to  collect,  416. 
time  of  payment  of -tax,  404. 

ASSESSMENT  INSURANCE' COMPANIES,  169. 

ASSESSMENTS  OF  TAX. 
abated,  how,  439. 
Iiow  made,  398. 


606  INDEX      . 

ASSESSMENTS  ON  STOCK,  281. 

ASSOCIATES,  WHEN  TREATED  AS  CORPORATIONS,  126. 

ASSOCIATIONS    TAXABLE    AS    CORPORATIONS,    126. 
dividends  from,  263. 

ASSOCIATIONS    FOR    MARKETING    PRODUCE,    EXEMPT 
WHEN,   202. 

ASSOCIATIONS   (FRATERNAL)   EXEMPT  WHEN,  1916. 

BAD  DEBTS,  34. 

see   Worthless   Debts. 

BALANCE  SHEET, 

must  show  depreciation  allowance,  356. 

BANK  DEPOSITS, 

interest  credited  on  is  income,  260. 
interest  on,  of  non-resident  aliens,  46. 
no  withholding  on  interest  on,  476. 

BANK  GUARANTY  FUNDS,  PAYMENTS  TO,  329. 

BANKS, 

foreign,  188. 

may  deduct  all  interest  on  deposits,  143. 

no  withholding  on  interest  paid  on  deposits,  476. 

BARTER  AND  EXCHANGE,  211. 

BEARER  STOCK  CERTIFICATES,  71.      *  " 

BENEFICIARIES, 

accident  insurance,  of,  280. 
estate  reported  as,  when,  88. 
file  own  returns,  unless,  93. 
income  from  trust  estates,  84,  95. 
life  insurance,  of,  282. 
non-resident  alien,  99. 
of  estates  in  foreign  countries,  99. 
returns  filed  for,  when,  93. 
who  are,   76. 

BILLS  RECEIVABLE,  238. 

BOARDS  OF  TRADE,  EXEMPT  WHEN,  199. 

BONDS  WITH  ACCRUED  INTEREST,  PURCHASE  OF,  259. 

BONDED  AND  OTHER  INDEBTEDNESS,  160. 


INDEX  607 

BONDHOLDERS, 

covenants  to  pay  tax  for,  482. 
income  from  tax-free  bonds,  40. 
tax  paid  for,  145. 

BOND  INTEREST,  DEFINED,  461. 

BONDS, 

depreciation  not  allowed,  349. 
issued  below  par,  337. 
purchased  above  par,  339. 
retirement,  purchase  of,  for,  338. 

BONDS  ISSUED  FOR  PUBLIC  PURPOSES,  INTEREST  ON, 
258. 

BONUS, 

deductible   when,   315. 

fixed  and  determinable  income,  when,  459.  . 

gifts,  when,  316. 

i)icome,  when,  230. 

paid  by  lessees  of  oil  or  gas  property,  368. 

taxable  when  received,  229. 

BOOKKEEPING, 
farmers,  242. 
•    reporting  income  on  basis  of,  227. 

BOOKKEEPING  ENTRIES, 

allowance  for  depletion,  363. 

allowance  for  depreciation,  355. 

constitute  neither  loss  nor  gain,  352. 

deductions  reported  according  to,  298. 

except  when,  209. 

losses  must  l)e  charged  off,  when,  333. 

not  conclusive  as  to  income,  208. 

worthless  debts  must   be  evidenced  by,  343. 

BOOKKEEPING  SYSTEM,  209. 

BOOKS, 

examination  of  taxpayers',  431. 

BOOKS  OF  ACCOUNT,  209. 

BOOK  VALUE  OF  ASSETS,  210. 

BOOK  VALUES, 

depreciation  not  based  on,  352. 
fluctuations  in,  333. 


608  INDEX 

BOOK  VALUES— Cont. 

not  conclusive  in  sale  of  property,  246. 
profit  not  based  on,  247. 
writing  off,   352. 

BROKEES, 

interest  received  and  paid  by,  260. 
must  report  names  of  customers,  451. 

BUILDING  AND  LOAN  ASSOCIATIONS, 
exempt  when,  197. 
matured  shares  in,  income  from,  289. 

BUILDINGS  ERECTED  BY  TENANT,  252. 

BUILDINGS  USED  FOR  RENTAL  PURPOSES,  30. 

BUREAU  OF  INTERNAL  REVENUE,  3. 

BU'SINESS  ASSOCIATIONS,  EXEMPT  WHEN,  199. 

BUSINESS  EXPENSES, 

citizens  and  residents,  30. 
corporations,  135. 
deductible,  when,  304. 
fiduciaries,  80. 
foreign  corporations,  185. 
non-resident   aliens,   51. 
trust  estates,  80. 

BUSINESS,  INCOME  FROM,  236. 

BUSINESS  OR  TRADE,  DEFINED,  32. 

CAMPAIGN  EXPENSES,  CONTRIBUTIONS  TO,  307. 

CAPITAL, 

loss  of,  334. 

worthless  debts  representing,  342. 

CAPITAL  ASSETS,  SALE  OF,  245. 
Gray  v.  Darlington,  245. 

CAPITAL  ORIGINALLY  INVESTED, 
in  mines,  375. 
in  oil  or  gas  deposits,  364. 

CAPITAL  STOCK  ISSUED  FOR  LESS  THAN  PAR,  335. 

CAPITAL  STOCK,  PROCEEDS  FROM  SALE  OF,  135. 
redemption  of  preferred,  137. 


.  i 


INDEiX  609 

CARRYING  CHARGES, 

added  to  oost  of  property,  when,  246. 

CASE  1  (CAPITAL  STOCK  TAX),  543. 

CASE  2  (CAPITAL  STOCK  TAX),  544. 

CASE  3    (CAPITAL  STOCK  TAX),  545. 

CASH  DISBURSEMENTS,  298. 

CASH  DIVIDENDS,  271. 

CASH,  EQUIVALENT,  OF,  212. 

CASUALTY  INSURANCE  COMPANIES,  172. 

CEMETERY  COMPANIES,  EXEMPT  WHEN,  199. 

CERTIFICATE  OF  PROBABLE  CAUSE,  448. 

CERTIFICATES  OF  INDEBTEDNESS, 
interest  credited  on,  260. 

CESTUI  QUE  TRUST,  76. 

CHAMBERS.  OF  COMMERCE,  EXEMPT  WHEN,  199. 

CHARGES  FOR  SERVICES,  207. 

CHARITABLE  ORGANIZATIONS,  EXEMPT   WHEN,   199. 

CHECKS  IN  PAYMENT  OF  TAX,  406. 

(IHILDREN, 
see  Minors, 
exemption  for,  37. 

CHRISTMAS  GIFTS,  231. 

CITIZENS  OF  THE  UNITED  STATES, 

deductions  and  exemptions  allowed  to,  29. 
dividends  received  by,  265. 

extent  to  which  taxable,  29.  * 

no  distinction  between  native  and  naturalized,  22. 
paying  out  income,  duty  when,  40. 
residing  abroad,  23. 
residing  in  the  United  States,  22. 
taxable  on  entire  net  income  from  all  sources,  22. 
tax  withheld  at  source,  when,  40. 
F.  I.  Tax— 39 


610  INDEX 

CITIZENSHIP    DETERMINED     BY     TREASUEY    DEPART- 
MENT, 22. 
effect  of  payment  of  income  tax,  23. 

CITY  EMPLOYEES,  EXEMPTION  OF,  22. 

CIVIC  ORGANIZATIONS,  EXEMPT  WHEN,   199. 

CLERGYMEN, 

voluntary  offerings  received  by,  231. 

CLUBS,  EXEMPT  WHEN,  199. 

COLLATERAL, 

interest  on  indebterlness  secured  by,  143. 
subject  of  sale  in  ordinary  business,  144, 

COLLECTING   INCOME   FOR   NON-RESIDENTS,    63. 

COLLECTION  AGENCIES,  455. 

COLLECTION  DISTRICTS,  3. 

COLLECTIONS  OF  FOREIGN  PAYMENTS,  455. 

COLLECTION  OF  TAX  AT  THE  SOURCE, 

abatement  and  refund,  475. 
agents,  on  payments  to,  470. 
against  whom  tax  withheld,  468. 
annual  list  returns,  480. 
banks,  interest  paid  by,  476. 
by  whom  tax  withheld,  476. 
corporations,  on  payments  to,  469. 
corporations  withhold  tax,  when,  476. 
debtors  withhold  tax,  when,  477. 
dividends,  procedure  in  paying,  479. 
employers  withhold  tax  when,  477. 
fiduciaries,  on  payments  to,  4§9. 
fiduciaries   withhold   tax  when,  477. 
fixed  or  determinable  income,  458. 
foreign  fiduciaries,  on  payments  to,   101. 

not  required  by,  102. 
foreign  partnerships,  on,  120. 

tax  not  withheld  at  present,  120. 
general  statement,  12. 
individuals,  on  payments  to,  469. 

interest  on  bonds  containing  covenants  to  pay  tax,  466. 
lessors  withhold  tax  when,  477. 
monthly  list  returns,  479. 
nominal  stockholders,  470. 


INDEX  611 


OOLLECTION  OF  TAX  AT  THE  SOURCE— Cont. 
non-resident  aliens,  credit  for  tax  withheld,  55. 

release  of  amounts  withheld,  56. 
officers  and  employees  of  U.  S.,  478. 
on  dividends,  when,  464. 
on  interest  of  domestic  corporations,  465. 
ownership  certificates,  471. 

disposition  of,  480. 
partnerships  on  payments  to,  469. 
partnerships,  domestic,  108. 
payment  to  government  of  tax,  481. 
payments  to  non-resident  aliens,  463. 
penalty  for  failure  to  withhold,  481,  425. 
procedure  in  collecting  income,  471. 
registered  interest,  478. 
release  of  amounts   withheld,   475. 
substitute  certificates,  473. 
substitute,  etc.,  use  of  discontinued,  475. 
withholding  agents,  duties  of,  478. 

COLLECTION  OF  TAX  BY  SUIT,  416. 

CX)LLECTORS  OF  INTERNAL  REVENUE, 
assistance  of,  in  making  returns,  390. 
injunction  suits  against,  400. 
letters  to,  5.  » 

may  extend  time  to  file  returns,  386. 
may  take  affidavits  to  returns,  389. 
may  summon  taxpayers,  432. 
personally  liable  if  tax  paid  under  protest,  408. 
return  made  for  taxpayer,  when,  390. 
suits  against,  445. 
interest,  448. 

COMMERCE,  INCOME  FROM,  236. 

COMMERCIAL  FARMING,  242. 

COMMERCIAL  PAPER,  461. 

COMMISSIONER  OF  INTERNAL  REVENUE,  3. 
assessments  are  made  by,  3. 
has  general  charge  of  internal  revenue,  3. ' 

COMMISSIONS, 

fixed  and  determinable  income,   when,  459. 

income  when  received,  232. 

paid   in   stock,  214,   306. 

reinsurance,  on,  mutual  companies,  171. 

real  estate  dgents,  306. 


612  INDEX 

COMPENgATION, 

based  on  stockholding,  315. 

officers  and  employees  of  a  state,  234. 

COMPENSATION  BY  INSURANCE,  290. 

COMPENSATION    FOR    PERSONAL    SERVICES, 
exempt  corporations,  paid  by,  230. 
received,  taxable  when,  229. 
services  extending  over  a  year,  232. 
taxable  in  whatever  form  paid,  229. 

COMPUTING  THE  TAX,  ILLUSTRATION,  17. 

COMPROMISE  OF  PENALTIES,  427. 

CONSERVATORS, 
are  fiduciaries,  73. 

CONSOLIDATION  OF  CORPORATIONS,  130. 

CONSTITUTIONAL  AMENDMENT,  2. 

CONSTITUTIONALITY  OF  LAW, 

examination  of  taxpayers'  books,  432. 

exemption  of  certain  classes  of  corporations,  493. 

not  tested  by  injunction  suits,  399. 

power  of  Congress  to  levy  tax,  488. 

retroactive  feature,  493. 

taxing  gains  and  profits  from  sale  of  property,  489. 

tax  on  foreign  steamship  companies,  179. 

uniformity,  493. 

want  of  due  process  of  law,  492. 

CK)NSTRUCTION  OF  LAW,  6. 

CONTINGENT  INCOME,  207. 

CONTINGENT    INTERESTS    IN    TRUST    ESTATES,    88. 

CONTINGENT  LOSSES,  300. 

CONTRACTING  COMPANIES, 
income  of,  238. 

CONTRIBUTIONS   TO  CHARITIES,  36. 

CO-OPERATIVE  BANKS,  EXEMPT  WHEN,  197. 

CO-OPERATIVE  ORGANIZATIONS,  EXEMPT.  WHEN,  201. 


INDEX  Gi;j 


CO-PARTNERSHIP, 

see  Partnerships. 

(X)PYRIGHTS,  ROYALTIES  FROM,  295. 

CORPORATIONS, 

annual  return,   157. 

filed  when  no  net  income,  157. 

when  filed,  157. 

where  filed,  157. 
assessments  on  stock,  281. 
associations  are,  126. 
bonded  and  other  indebtedness,  160^ 
bonds  issued  below  par,  337. 
books  of  account,  effect  of,  209. 
l)rokera,  report  of,  163. 
capital  stock  tax,  534.  « 

capital  stock,  sale  of,  135. 

redemption  of,  137. 
capital  stock, 

paid  up,  142. 
collateral  subject  to  sale,  144. 
collection  of  tax  from  assets,  131. 
t'oUection  of  tax  at  source,  165. 
consolidating  during  year,  130. 
(lealer  only,  definition,  144. 
deductions  allowed  to,  11?5. 
deficit,  contribution  to  make  good,  281. 
definition  of  term,  126. 
dissolving  during  year,   130. 

l)efore  enactment  of  1917  Law,  131. 
dividends  from  other  corporations,  146. 
dividend  payments,  report  of,  162. 
dividends  received  by,  266. 
doing  business  not  material,  125. 
domestic,  dividends  of,  264. 
excess  profits,  tax  on,  503. 
exempt,  when,  193. 
expenses,  ordinary,  135. 

interest  aa  expense,  when,  144. 
fiscal  year,  153. 

change  to  calendar  year,  156. 

how  designated,  154. 

new  cor]>oration8  may  designate,  155. 

notice  of,  156. 

requirements   as   to,    154. 
foreign,  see  Foreign  Corporations, 
foreign  countries,  operating  in,  128. 
gifts  to,     134,  283. 

subsidiaries,  149. 
holding  com]>anies,  146. 

legal  title  to  earnings  of  subsidiaries,  14N. 


614 


INDEX 


CORPOEATION&— Cont. 

income  subject  to  tax,  133. 
indebtedness  outstanding  at  close  of  year,  142. 
insurance  companies  are,  126. 
interest-bearing  indebtedness,    140. 
interest,  deduction  of,  137. 

indebtedness  secured  by  collateral,  143. 
different  rates  of,  141. 
limitation  of,  138. 
on  mortgage  not  assumed,  140. 
on  tax-free  bonds,  145. 
paid   by  banks,   143. 
tax  paid  on,  for  bondholders,  145. 
joint  stock  companies  are,  126. 
lessor  and  lessee  corporations,  149. 
liability  for  tax  after  dissolution,  131. 
liquidating  during  year,  130. 
losses,  137. 

merging  during  year,  130. 
name,  change  of,  130. 
newly  organized,  129. 
non-resident,  dividends  of,  264. 
operating  entirely  abroad,  128. 
ordinary  business,  defined,  145. 
organization  expenses,  136. 
organized  during  year,  129. 
owned  by  exempt  corporations,  202. 
parent  companies,  146. 

payments  of  dividends  to  be  reported,  452. 
payments  in  lieu  of  rent,  136. 
payments  of  income,  report  of,  163. 
payments  of  interest  to  be  reported,  452. 
Philippines,  operating  in,  129. 
Porto  Rico,   operating  in,  129. 
principal  office,  defined,  157. 
private  banks  are,  when,  127. 
property  acquired  for  stock,  247. 
receivers  of,  152. 

corporations  in  hands  of,  taxable,  153. 
redemption  of  preferred  stock,  137. 
residence  of,  128. 
resident,  dividends  of,  264. 
retirement  of  bonds,  338. 
return  of  annual  net  income,  157. 
by  whom   filed,   158. 
how  prepared,  159. 
how  signed  and  sworn  to,  162. 
returns  may  be  inspected,  when,  394. 
salaries  paid  to  stockholders,  230. 
separate  entities,  125. 
sinking  funds,  income  from,  281. 


INDEX  615 

CORPORATIONS— Cont. 
special  returns  by,  162. 
s|)ecific  exemption,  not  entitled  to,  125. 
stockholders  of  lessee,  151.  * 

stock  outstanding,  159. 
state,  national,  etc.,  bonds,  161. 
statutory  office,  158. 
supertax  not  imposed  on,  15. 
subsidiary  companies,  146. 

inactive,  147. 
syndicates  are  not,  126. 
tax  not  excise  tax,  125. 
taxes,   146. 
treasury  stock,  159. 
trusts  are,  when,  127. 
undistributed  j)rofit8,  report  of,  164. 
withliolding  tax  at  source,  165. 

CORPORATION  TAX,  12. 

CXDRRESPONDENCE,  GOODS  SOLD  BY,  177. 

COST, 

inventory  taken  at,  2.'i7. 
of   timberlands,   291. 

COST  OF, 

drilling  wells  for  oil  or  gas,  370. 

manufactured  products,  305. 

new  buildings  to  include  loss  on  property  destroyed  incident  to 

construction,  302. 
patents,  294. 

COST  OF   PROPERTY,  246. 
depreciation  based  on,  350. 
received  in  exchange  for  stock,  212. 
when  acquired  by  gift,  284. 

COUNTY  EMPLOYEES,  EXEMPTION  OF,  22. 

COUNTY  FAIRS,  ASSOCIATIONS  EXEMPT,  WHEN,  196. 

COURT  OF  CLAIMS, 
suit  in,  43. 

COURTS, 

construction  of  law  by,  7. 

COVENANTS  TO  PAY  THE  TAX,  482. 
defined,  462. 
forms  of,  483. 
ojierate  when,  482. 


616  INDEX 

CREDITORS, 

of  insolvents,  77. 

CREDITS  IN  FOREIGN  COUNTRIES,  224. 

CROP  SHARES,  243. 

CUSTOMS  DUTIES,  307. 

DAMAGES,  AMOUNT  RECEIVED  AS,  281. 

DEALER, 

interest  deductible  by  corporation  as,  144. 

DEBTS,  DEDUCTION  OF  WORTHLESS,  34. 

DECEDENT,  PROPERTY  LEFT  BY,  249. 

DECEDENTS'  ESTATES, 

income  received  during  settlement  of,  86. 

Declarations  of  trust,  126. 
deduction  at  the  source,  12. 
deductions, 

accounts  payable,  307. 

accruals  to  meet  fixed  charges,  299. 

actual,  must  be,  297. 

additions  and  betterments,  301. 

alterations,  cost  of,  310. 

assessments  against  local  benefits,  303. 

bank  guaranty  funds,  ])aynients  to,  329. 

bonus,  payments  of,  31.5. 

book  entries,  reporting  according  to,  298. 

business  expenses,  304. 

commissions,  306. 

contributions  to  political  parties,  307. 

cost  of  manufactured  products,  305. 

customs  duties,  307. 

depletion  of  oil  and  gas  deposits,  360. 

depletion  of  mines,  373. 

depreciation,  346. 

discounts,  307. 

donations,  317. 

duplication  of,  304. 

entertainment  money,  307. 

expenses  in  earning  exempt   income,   30.5. 

expenses  of  business,  304. 

of  operation,   30.5. 
farmers,  by,  318. 


INDEX  617 


DEDUCTIONS— Cont. 

general  statement,  296. 

gifts  to  employees,  316. 

gratuities,  316. 

improvements,  308. 

instalments,  unpaid,  344. 

insurance  premiums,  312. 

interest,  320. 

losses,  331. 

loss  of  earnings  not  allowed  as,  297. 

maintenance  of  property,  expense  of,  308. 

new  equipment,  309. 

obsolescence,  loss  due  to,  349. 

payment  in  lieu  of  rent,  311. 

pensions,  317. 

profit-sharing  payments,  315. 

public  utility,  by,  when,  319. 

partnershij>s,  allowed  to,  109. 

premiums,  insurance,  312. 

removal  of  buildings,  302. 

repairs,  308. 

reserves  to  meet  liabilities,  300. 

restoring  property,  expense  of,  302. 

royalties,  318. 

salaries,  313. 

statute  specifies,  297. 

taxes,  324. 

tenant  by,  311. 

voluntary  destruction  of  property,  302. 

worthless  debts,  342. 

DELAY  IN  PAYMENT  OF  TAX, 
penalty  for,  425. 

DELINQUENT  TAXES,  INTEREST  ON,  416. 

DEMAND  FOR  TAX,  401. 

DEPLETION,  ALLOWANCE  FOR, 

citizens  and  residents,  deductible  by,  35. 
dividends  from  reserves  for,  271. 
foreign  corporations,  deductible  by,  187. 
non-resident  aliens,  deductible  by,  54. 
trust  estates,  deductible  by,  83. 

DEPLETION  OF  MINES, 
allowance  for,  373. 
basis  of  deduction,  374. 
capital  invested,  375. 
cost  of,  375. 
depreciation  not  included  in,  373. 


618  INDEX 

DEPLETION  OF  MINES— Cont. 

fair  market  value  March  1,  1913,  376. 

lessees  not  entitled  to,  374. 

owner  entitled  to  claim,  374. 

rate  of  deduction,  377. 

separate  deposits,  379. 

statement  attached  to  annual  return,  379. 

DEPLETION  OF  OIL  AND  GAS  WELLS, 
basis  of  deduction,  363. 
book  entries  of,  363. 
capital  originally  invested,  364. 
deduction  hj  lessees,  367. 
depreciation  not  included  in,  361. 
fair  market  value  March  1,  1913,  364. 
lessee  may  not  claim,  when,  361. 
owner  of  property  only  may  claim,  363. 
rate  of  annual  deduction,  365. 
reduction  of  production  and  flow,  366. 
statement  attached  to  annual  return,  370. 

DEPOSITS, 

interest  on,  deducted  by  bank,  143. 
interest  on,  paid  by  foreign  banks,  188. 

DEPRECIATION, 

annual  allowance,  353. 
apartment  houses,  355. 
based  on  cost  of  property,  350. 
•bonds,  349. 

citizens  and  residents,  deduction  by,  35. 
claim  disallowed,  procedure  when,  356. 
copyright,  295. 
deduction  of,  346. 

depletion  is  separate  allowance,  361. 
dividends  from  reserves  for,  271. 
farm  buildings  and  machinery,  348. 
good  will,  349. 
incidental  repairs,  353. 
investment  of  reserves  for,  357. 
lessees  of  oil  and  gas  properties,  369. 
lessees,  claimed  by,  358. 
life  of  property,  how  determined,  353. 
live  stock,  348. 
merchandise  in  stock,  348. 
obsolescence,  349. 
oil  operators'  equipment,  361. 
patents,  of,  294. 

property  must  be  subject  to  wear  and  tear,  346. 
rate  of,  355. 
real  estate,  not  allowed  on,  347. 


INDEX  619 

DEPRECIATION— Cont. 

renewals  to  property,  353. 

rental  value  of  building  not  subject  to,  347. 

reserves  for,  357. 

stocks,  349. 

tangible  jiroperty  only,  on,  350. 

timbcrlands,  of,  290. 

trust  estates,  deductible  by,  82. 

unearue<l  increment,  350. 

wearing  apparel,  348. 

DEPUTY  COLLECTORS) 

may  take  afiSdavit  to  Tetums,  when,  389. 

DESTRUCTION  OF  PROPERTY, 
by  fire,  storms,  etc.,  339. 

DETERIORATION  OF  PROPERTY  IN  STORAGE,  341. 

DISCOUNTS,  307. 

DISSOLUTION  OF  COPORATIONS,  130. 

DISTRAINT,  COLLECTION  OF  TAX  BY,  419. 

DISTRIBUTION  OF  ASSETS, 
taxable  as  dividend  when,  262. 

DISTRICT  IN  WHICH  INDIVIDUALS  FILE  REURN8,  383. 

DISTRICT  IRRIGATION  BONDS,  .342. 

DISTRICT  OF  COLUMBIA, 
income  accruing  to,  203. 
oflScers  and  employees,  of,  234. 

DITCH  COMPANIES,  MUTUAL,  EXEMPT  WHEN,  201. 

DIVIDENDS, 

amounts  paid  by  lessee  corporations,  151. 

associations,  from,  263. 

cash,  281. 

corporations,  deductible  by,  when,  146. 

credit  for  normal  tax,  36. 

deemed  to  be  from  most  recent  accumulation,  268. 

definition  of,  262. 

earnings  prior  to  March  1,  1913,  269. 

exemjit  only  to  stockholders,  270. 
estates,  received  by,  271. 
extent  to  which  taxable,  264. 
life  insurance  policies,  on,  263. 


620  INDEX 

DIVIDENDS— Cont. 

non-resident  alients,  how  reported,  54. 
non-resident  aliens,  taxability  of,  44. 
paid  in  equivalent  of  cash,  272. 
paid  in  Liberty  bonds,  273. 
partnerships,  received  by,  113. 
profits  prior  to  March  1,  1913,  270. 
rate  of  tax  on,  264. 
reserves  for  depreciation,  from,  271. 
salaries  held  to  be,  when,  230. 
scrip,  271. 
stock,  paid  in,  274. 
stock  not  owned  by  recipient,  66. 
stock,  surplus  on  reorganization,  220. 
taxes  paid  for  stockholders  are,  273. 
taxable  in  year  received,  223. 
withholding  tax  on  payment  of,  464. 

DIVIDENDS  ON  LIFE  INSURANCE  POLICIES,  288. 

DOMESTIC  COEPORATIONS  OPERATING  ABROAD, 
dividends  of,  45. 

DONATIONS  BY  CORPORATIONS,  317. 

DUE  PROCESS  OF  LAW,  492. 

DURESS,  PAYMENT  OF  TAX  UNDER,  409. 
notice  and  demand,  411. 
second  notice  and  demand,  411. 

DUTCH  ADMINISTRATION  OFFICES,  70. 

DUTIES,  CUSTOMS,  307. 

DWELLING  HOUSE,  NO  DEPRECIATION  ALLOWED  ON,  346. 

EDUCATIONAL  ORGANIZATIONS,  EXEMPT,  WHEN,  199. 

EMPLOYEES, 

premiums  paid  by,  on  bonds,  313. 

EMPLOYEES '  LIABILITY  COMPANIES,  172. 

ENDOWMENT  POLICIES,  INCOME  FROM,  289. 

ENTERTAINMENT  MONEY,   307. 

ENTITIES, 

corporations  taxed  as,  125. 

limited  partnerships  taxed  as,  103. 

trust  estates  taxed  as,  89. 


INDEX,  G21 

EQUIPMENT,  COST  OF,  309. 

EQUITY, 

bill  in  to  restrain  collection  of  tax,  399. 

EQUIVALENT  OF  CASH, 
dividends  paid  in,  272. 

EQUIVALENT  OF  CASH,  INCOME  RECEIVED  IN,  212. 
living  quarters,  board,  lodging,  221. 
notes,  221. 

ERRONEOUS  RETURNS,  391. 

ESTATES  OF  DECEASED  PERSONS, 
specific  exemption  allowed  to,  38. 

EXAMINATION  OF  TAXPAYER'S  BOOKS,  431. 
refund  of  overpayment  discovered  by,  442. 

EXCESS  PROFITS  TAX,  503. 

EXCESS    PROFITS    TAXES    DEDUCTED    FROM    NET    IN- 
COME, 326. 

EXCHANGE  OF  STOCK,  217. 
loss  on,  334. 

EXCISE  TAX  (CAPITAL  STOCK  TAX),  534. 

EXCISE  TAX, 

1916  Law  does  not  impose,  125. 
1913  Law  provided,  when,  125. 

EXECUTORS, 

acting  also  as  receiver  in  partition  proceedings,  8S. 
are  fiduciaries,  75. 
commissions  of,  81. 
decedents,  returns  of  income  of,  27. 
duties  of,  77. 

income  received  by,  during  settlement  of  estate,  86. 
how  reported,  87. 

EXEMPT  CORPORATIONS, 
enumeration  of,  195. 
extent  of  exemption,  193. 
foreign,  177. 

status  established,  how,  193. 
interest  on  obligations  of,  259. 
not  exempt  from  duty  to  withhold,  193. 
only  classes  enumerated  are,  194. 


622  INDEX 

EXEMPT  CORPOKATIONS— Cont. 
question  as  to  exemption,  194. 
right  must  be  proved,  195. 
salaries  paid  by,  230. 
when  exempt,  193. 

EXEMPT  DIVIDENDS,  269. 

EXEMPT  INCOME, 

expense  incurred  in  earning,  305. 

general  statement,  226. 

not  subject  to  withholding,  460.  ^ 

omitted  from  annual  return,  21. 

EXEMPT  INTEREST,  255. 

EXEMPT  PERSONS,  21. 

EXPECTATION  OF  RECEIVING  MONEY,  NOT  INCOME,  206. 

EXPENSES, 

foreign  corporations,  deductible  by,  186. 
non-resident  aliens,  deductible  by,  51. 

EXPORT  BUSINESS, 
income  from,  238. 

EXTENSION  OF  TIME  TO  FILE  RETURNS,  386. 

FAILURE  TO  RECEIVE  FORMS,  388. 

FALSE  RETURNS,  424. 

FARMERS, 

cost  of  live  stock,  how  deducted,  248. 
deductions  claimed  by,  243. 
depreciation  on  farm  buildings,  348. 

stock  for  breeding  purposes,  348. 
expenses,  deductible  by,  318. 
income  of,  242. 
losses  deductible  by,  340. 

FARMERS'  MUTUAL  OR  CO-OPERATIVE  COMPANIES,  201. 
associations  for  marketing  produce,  202. 

FEDERAL  JUDGES,  COMPENSATION  OF,  235. 

FEDERAL  LAND  BANKS,  EXEMPT,  202. 

FEDERAL  OFFICERS  AND  EMPLOYEES,  COMPENSATION 
OF,  232. 


INDEX  623 

FEDERAL  BE8ERVE  BANKS, 
dividenda  of,  exempt,  204. 
income  of,  exempt,  204. 

FEES,  229. 

see  Compensation. 

FIDELITY  BONDS,  PREMIUMS  ON,  313. 

FIDUCIARIES, 

acting  in  more  than  one  estate,  92. 
agents  are  not  fiduciaries,  74. 
annual  return  of  net  income,  90. 

where  filed,  92. 
beneficiaries,  returns  filed  for,  when,  93. 
domestic  fiduciaries,  73. 
duties  of,  77. 
foreigners  acting  as,  98. 
income  not  actually  paid  out,  84. 
income  of  several  years,  when  distributed,  85. 
income  of  trust  estate,  84. 

income  received  from,  by  non-resident  aliens,  48. 
incompetents,  returns  filed  for,  84. 

indemnified  and  claims  and  demands  for  payments  of  tax,  77. 
information  at  source,  duty  to  report,  97. 
may  file  returns  for  beneficiary,  when,  93. 
minors'  returns  filed  for,  84. 
non-resident  beneficiary,  duty  in  case  of,  84. 
non-resident  aliens  acting  as,  98. 
uon-resident  aliens,  returned  filed  for,  84. 
only  one  beneficiary,  return  in  case  of,  94. 
power  of  attorney,  74. 
required  to  pay  tax,  when,  77. 
returns  by,  90. 
sui)ertax,  when  paid  by,  84. 
witliholding  by,  96. 
withholding  tax  against,  96. 
withholding  tax  at  source,  84. 

FIFTY  PER  CENT  PENALTY, 
cannot  be  compromised,  429. 
failure  to  file  returns,  for,  422. 

FINES  FOR  FALSE  STATEMENT  IN  RETURNS,  425. 

FIRE  INSURANCE,  MONEY  FROM,  290. 

FIRE,  LOSS  BY,  33. 

FIRMS, 

see  Partnership. 


624  INDEX 

FIRST  COLLECTION  AGENCIES,  455. 

FISCAL  YEAR, 

corporations  may  designate,  153. 

change  to  calendar  year,  156. 

how  designated,  154. 

requirements  as  to,  154. 
partnerships  may  fix,  113. 

ending  in  year  rates  are  changed,  114. 

FIVE  PER  CENT  PENALTY, 
delay  in  payment  of  tax,  425. 

FIXED  CHARGES,  ACCRUAL  OF,  299. 

FIXED  OR  DETERMINABLE  INCOME,  458. 
withholding  tax  on,  463. 

FOREIGN  ASSESSMENT  INSURANCE  COMPANIES,  169. 

FOREIGN  BANKS,  188. 

FOREIGN  CORPORATIONS, 
agents  for,  59,  182. 

returns  filed  by,  190. 
annual  return  of,  189. 
branch  of,  agent  regarded  as,  178. 
branches  in  U.  S.,  184. 
capital  stock  tax,  551. 
chartered   ships,  179. 
collection  of  tax  at  source,  against,  181. 
deductions  allowed  to,  185. 

when  income  from  investments,  185. 
depletion  of  natural  resources,  187. 
depreciation,  deductible  by,  186. 
dividends  of,  paid  to  non-resident  aliens,  45. 
doing  business  in  U.  S.,  178. 
excess  profits,  tax  on,  503. 
exempt  corporations,  177. 
expenses,  186. 
foreign  banks,  188. 
foreign  insurance  companies,  187. 
income  of,  176. 
income  subject  to  tax,  183. 

steamship  companies,  183. 
interest,  deductible  by,  187. 
investments  of,   184. 
losses  deductible  by,  186. 

Nineteen  Hundred  and  Thirteen  Lnvv.  rules  as  to,  1 76. 
nominal  stockholders,  69. 

when,  182. 


iXDEz  625 


FOREIGN  CORPORATIONS— Cont. 
non-resident  alien  corporations,  181. 
ordinary  and  necessary  expenses,  186. 
paying  out  income,  189. 

payments  of  dividends  to  be  reported,  wlien,  452. 
,         payments  of  interest  to  be  reported,  when,  453. 
resident  agents  for,  182. 
resident  alien  corporations,   180. 
return  of  net  income,  189. 

by  whom  filed,  190. 

filed  by  agent,  190. 

how  prepared,  191. 

when  filed,  190. 

where  filed,  190. 
sale  of  goods  by  correspondence,  177. 
ships  chartered  to  residents,  179. 
ships  touching  American  ports,  180. 
special  returns  by,  191. 
steamship  companies,  179. 

income  of,  183. 
storing  goods  in  U.  8.,  178. 
taxable,  when,  177. 
taxes,  deductible  by,  189. 
tramp  steamers,  179. 
transacting  business  in  U.  8.,  178. 
traveling  salesmen,  177. 

FOREIGN  COUNTRIES, 
persons  taxable  in,  21. 

FOREIGN    FIDUCIARIES, 

beneficiaries,  return  for,  99. 

definition  of  term,  98. 

duties  of,  98. 

distribution  of  income  by,  99. 

return  of  net  income  by,  100. 

tax  not  withheld  by,  102. 

tax  withheld  on  payment  to,  101. 

trust  estate  in  hands  of,  98. 

undistributed  income  in  hands  of,  99. 

FOREIGN  GOVERNMENTS,  180. 

FOREIGN    INSURANCE    COMPANIES,   166. 

FOREIGN   PARTNERSHIPS, 
see  Partnerships, 
agents  for,  121. 

agents  for,  required  to  file  returns,  when,  60. 
citizens  and  residents,  partners  of,  117. 
collecting  income,  procedure,  122. 
F.  I.  Tax.— 40 


626  INDEX 

FOEEIGN  PARTNEESHIP&— Cont. 
defined,  117. 

extent  to  which  taxable,  122. 
general,  119. 
income  of,  117. 

limited,  118.  , 

no   withholding  against,   469. 
nominal  stockholders,  69. 
non-resident,  119. 

non-resident  alien,  partners  of,  117. 
paying  out  income,  122. 
resident,  119. 
returns  by,   123. 
special  returns,  123. 

FORMS, 

'  failure  to  receive,  388. 
of  annual  returns,  388. 
usually  sent  to  taxpayers,   388. 

FRAUDULENT    RETURNS,  424. 

'FRUIT  GROWERS'  ASSOCIATIONS,  EXEMPT  WHEN,  202. 

GAINS  AND  PROFITS  FROM  SALE  OF  PROPERTY,  245. 
see  Sale  of  Property, 
""constitutionality  of  tax  on,  489. 

GAS    WELLS,  362. 

GAS    WELLS,  DEPLETION    OF, 

citizens  and  residents,  deduction  by,  35. 

GENERAL    PARTNERSHIPS,  106. 
of  foreign  countries,  119. 

GENTLEMEN    FARMERS,  242. 

GIFT, 

property  acquired  by,  21. 
property  left  by  decedent,  249. 

GIFTS, 

contribution  to  charities,  36. 

corporations  receiving,  134. 

deducted  from  net  income,  when,  36. 

definition   of,   284. 

legacies,   283. 

pensions,  when,  283. 

property  acquired  by,  283. 

salary  paid  to  widow  of  deceased,  284. 

to  clergymen,  income  when,  231, 


INDEX  627 

GOOD    WILL, 

depreciation  not  allowed,  349. 

GOODS  SOLD  ON  APPROVAL,  239. 

GOVERNMENT    OFFICES    AND    EMPLOYEES,    COMPEN- 
SATION   OF,  232. 

GRADUATED   RATES   OF    SUPERTAX,    15. 

GROSS    INCOME, 

in  general,  225,  2.37. 
insurance  companies,  166,  237. 
manufacturing  companies,  236. 
mercantile  companies,  236. 

GROSS  RECEIPTS,  NOT  GROSS  INCOME,  225. 

GUARANTEE    OF    DIVIDENDS   OF    ANOTHER    CORPORA- 
TION, 336. 

GUARDIANS,  ' 

are  fiduciaries^  74. 
foreigners  acting  as,  98. 
non-resident  aliens  as,  98. 
person   exemption   for  ward,  37. 

HEAD    OF    FAMILY, 

definition   of   term,   38. 
personal  exemption  of,  37. 

HEAT  AND  LIGHT,  PAYMENT  IN,  23.3. 

HOLDING    COMPANY,  146. 

supertax   on   undistributed   profits   of,   19. 

HORTICULTURAL  ORGANIZATIONS,  WHEN  EXEMPT,  195. 

HUSBAND    AND    WIFE, 

exemption   on   second   issue  Liberty   Bonds,  256. 

family   treated  as  a  unit,  25. 

personal  exemption  of,  39. 

returns  of,  joint  when,  383. 

supertax  on  8e))arate  incomes  of,  18. 

wife  assumes  citizenship  of  husband,  22. 

wife  assumes  nationality  of  husband,  42. 

IMPROVEMENTS    AND    BETTJCRMENTS, 
added   to  cost,  246. 
no  deduction  allowed  for  permanent,  35. 

IMPROVEMENTS,    COST    OF,  308. 


628  INDEX 

IMPROVEMENTS  MADE  BY  TENANT,  252. 

INACTIVE    CORPORATIONS,    147. 

INCOME, 

accounts  receivable,  223. 

accruing  and  accrued,  206. 

accruing  to  state  or  local  governments,  203. 

actual  receipts,  207. 

agents,  receipts  of  by,  224. 

amount  to  be  reported  from  trust  estates,  95. 

barter  does  not  produce,  211. 

beneficiaries  to  report,  when,  86. 

shares  being  known,  88. 
board,  cash  value  of,  221. 
book  value  of  assets,  210. 
bookkeeping  entries,  208. 
change  in  form  of  assets,  213. 
credited  in   foreign  country,  224. 
decedent 's   estates,   86. 
definition  of,  205. 
exchange  of  property, 

no  value  fixed,  211. 
exchange  of  stock  for  property,  215. 

on   reorganization   of  corporation,   216. 
exchange  of  stock  for  stock, 

par  for  par,   217. 
exempt,  226. 

foreign  countries,  from,  224. 
general  discussion,  205. 
includes  receipts  by  agents,  224. 
income  received,   206. 
increase  in  book  values,  210. 
inventory,  when  determined  by*  211. 
living  quarters,  cash  value  of,  221. 
lodging,  cash  value  of,  221. 
loss  of  not  deductible  unless,  334. 
mortgages  receipts  in  form  of,  221. 
notes,  receipts  in  form  of,  220. 
paper  profits,  206. 
personal  services,  from,  229. 

see  Compensation, 
potential  income,  206. 
property  held  in  trust,  87. 
rate  of  exchange,  224. 
receipt  of,  206. 

received  in  equivalent  of  cash,  212. 
received  in  kind,  211. 
rent   received   in  produce,   211. 
specific  legacy,  how  treated,  87. 
stock  received  for  property,  215. 
stock  received  for  services,  214. 


INDEX  629 

INCOME— Cout. 

surplus  in  case  of  reorganization,  220. 

taxable  in  year  received,  223. 

travel  expenses,  222. 

trust  estates,  87. 

trust  estates,  amount  to  be  reported  by  beneficiary,  95. 

trust  estates,  how  treated,  84. 

undistributed  income  of  trust  estates,  85. 

worthless  debts  representing,  342. 

INCOMPETENTS, 

persons  acting  for,  76. 

returns  filed  for,  94. 

returns  made  by  guardian,  26. 

INCORPORATION    EXPENSES,   136. 

INCREASE  IN  BOOK  VALUE  OF  ASSETS,  210. 

INCREMENT  TO  SINKING  FUNDS,  281. 

INDEBTEDNESS, 

incurred  for  purchase  of  obligations,  bearing  exempt  inter- 
est, 322. 
interest-bearing,  of  corporation,  140. 
secured  by  collateral,  143. 

INDIVIDUAL   TAX   RATES,  15. 

INDIVIDUALS, 

annual  return,  9. 

dying  during  year,  27. 

excess  profits  tax  on,  503. 

exempt  from  tax,  21. 

personal  exemption,  10. 

returns  of,  may  be  inspected,  when,  393. 

returns  of,  where  filed,  385. 

to  whom  law  is  applicable,  20. 

INFORMATION   AT   THE   SOURCE, 
brokers,  by,  461. 

collection  of  foreign  items  of  interest  and  dividends,  455. 
dividend  payments,  452. 
foreign  fiduciaries,  by,  102. 
general  statement,  13. 
interest  payments,  402. 
miscellaneous  income  payments,  450. 
penalty  for  failure  to  file,  425. 
procedure  in  paying  income,  454. 
returns  of,  454. 

INHERITANCE    TAXES,  327. 


630  INDEX 

INJUNCTION  TO  EESTRAIN   ASSESSMENT   OF  TAX,  399. 
collection  of  penalties,  421. 

INSANE    PERSONS, 

penalty  for  failure  to  pay  tax,  426. 
returns  filed  for,  94. 

INSPECTION  OF  RETURNS  BY  PUBLIC,  392. 

INSPECTORS,  4. 

may  take  affidavits  to  returns,  when,  389. 

INSTALMENT    PAYMENTS, 
income  from,  292. 
unpaid,  deductible  when,  344. 

INSURANCE, 

charges  added  to  cost  of  property,  when,  246. 
fire,  proceeds  of  policies,  290. 

INSURANCE    COMPANIES,  126. 
see  also  Corporations, 
applied  surrender  values,  175. 
assessment  companies,  169. 
death  claims,  169. 

deduction,  net  addition  to  reserve,  167. 
deferred  dividends,  173. 
disability  claims,  169. 
dividends  on  premiums,  169. 
expenses  of,  167. 
gross  income  of,  166. 
instalment  policies,  169. 
life,  see  Life  Insurance  Companies, 
losses  on  policies,  169. 
matured  endowments,  169. 
mutual  casualty,  172. 
mutual  employers'  liability,  172. 
mutual  fire,  170. 
mutual  life,  175, 
mutual  marine,  172. 
mutual  workmen's  compensation,  172. 
net  addition  to  reserves,  167. 
payments  on  policies,  169. 
reinsurance  and  return  premiums,  167. 
reserves  of,  167. 

for  loss  and  unpaid  liability  claims,  168. 

for  unpaid  taxes,  168. 

released,  169. 

required  by  law,  168. 
special  provisions  applying  to,  166. 


INDEX  631 


INSURANCE  COMPANIES— Cont. 

supplementary  policy  contracts,  174. 

consideration  for,   169. 
uncollected  and  deferred  premiums,  208. 

INSURANCE    POLICIES, 

proceeds  of,  when  exempt,  21. 

INSURANCE    PREMIUMS, 

on  fire  insurance  deductible,  312. 

except  when,  30. 
on  life  insurance  not  deductible,  312. 
corporations,  312. 
individuals,  30. 
partnerships,  109. 

INTENTIONAL  NEGLECT  TO  FILE  RETURNS,  424. 

INTEREST, 

accrued  at  time  of  purchase  of  bonds,  259. 

accrued  but  unpaid,  208. 

accruing  prior  to  March  1,  IQl.*},  260. 

banks,  paid  by  on  deposits,  143. 

citizens  and  residents,  deduction  of,  31. 

corporation,  amount  deductible  by,  137. 

deductible  by  non-resident  aliens,  .52. 

deduction  of,  320.* 

delinquent  taxes  on,  416. 

fixed  and  determinable  income,  when,  459. 

foreign  corporations,  deductible  by,  187. 

income  from,  255. 

income  to  non-resident  aliens,  when,  46. 

indebtedness  secured   by   collateral,  143. 

national  bonds  and  obligations,  on, 

received  by  partnerships,  112. 
not  deductible,  when,  322, 

of  domestic   corporations  operating  abroad,  46. 
on  bank  deposits  of  non-resident  aliens,  47. 
paid  by  non-resident  citizens,  47. 
paid  within  year,  322. 
partnerships,  amount  deducted  by,  110. 
recovery  of  on  taxes  paid,  447. 
states  and  political  subdivisions,  on, 

received  by  partnerships,  112. 
trust  estates,  deductible  by,  81. 

INTEREST  BEARING    INDEBTEDNESS, 
of  corporations,  definition,  140. 

INTERSTATE    COMMERCE    COMMISSION, 
accounting  rules  of,  227. 


632  INDEX 

INVENTORY, 

determines   income,   when,   211. 

how  taken,  237. 

must  be  taken  at  cost,  211. 

INVESTED    CAPITAL,  513^  S  1 1-  i 

INVESTMENTS,    EXCHANGE    OF,   213. 

IRRIGATION    COMPANIES,    EXEMPT    WHEN,   201. 

JOINT-FIDUCIARIES, 

annual  return  filed  by  whom,  90. 

JOINT  RETURNS  OF  HUSBAND  AND  WIFE,  383. 

JOINT  STOCK  COMPANIES,  126. 
dividends  from,  263. 

JOINT-STOCK  LAND  BANKS,  EXEMPT  INCOME  OF,  202. 

KIND,    INCOME    RECEIVED    IN,    211. 

LABOR  ORGANIZATIONS,  WHEN  EXEMPT,  195. 

LANDLORDS, 

commissions  paid  to  real  estate  agents,  306.  > 

insurance  premiums   deductible,  when,  312. 

lessor  and  lessee  corporations,  149. 

may  deduct  expenses  of  buildings  rented,  30. 

but  not  for  dwelling  house,  30. 
rent  income  when  received,  unless,  252. 
repairs  made  by  tenant,   311. 
taxes  paid  by  tenant,  311,  330. 
value  of  improvement  made  by  tenant,  252. 

LAST  DUE  DATE  TO  FILE  RETURNS,  386. 

LAW  CONSTRUED  IN  FAVOR  OF  TAXPAYER,  6. 

LEGACY, 

income  from,  282. 

specific  legacy,  income  from,  87. 

value  of,  249. 

LEGATEES, 

are  beneficiaries,  97. 

income  from  specific  legacy,  87. 

LESSEE, 

corporations,  150. 

may  recover  tax  of  lessor,  when,  437. 
.       tenants,  see  Tenants. 


INDEX  •      633 

LESSEES    OF   MINES, 
deductions  by,  318. 

LESSEES  OF  OIL  AND  GAS  PROPERTIES, 
bonus  paid  by,  368. 
cost  of  lease,  368. 
depreciation  claimed  by,  369. 
royalties  paid  by,  367. 
statement  by,  371. 

LESSORS    AND    LESSEES, 

corporations,  income  of,  149. 

LETTERS  TO  COLLECTORS,  5. 

LEVEE  DISTRICTS,  INTEREST  PAID  BY,  258. 

LIBERTY  BONDS,  256. 
dividends  paid  in,  273. 

LICENSE   OF   FIRST   COLLECTION    AGENCIES,   456. 

LIEN  FOR  UNPAID  TAXES, 

dissolved  corporations,  for  tax  on,  132. 
including  interest  and  penalties,  417. 
notice  of,  417. 
time  when  attaches,  418. 

LIFE  INSURANCE  COMPANIES, 
applied  surrender  values,  170, 

to  be  reported  and  deducted,  175. 
consideration  for  supplementary  contracts,  169. 

to  be  reported  and  deducted,  175. 
supplementary  policies  contracts,  174. 

LIFE   INSURANCE   POLICIES, 

dividends  on,  263,  288. 
proceeds  of,  282. 
surrender    value    of,    288. 

LIFE   INSURANCE   PREMIUMS, 
see  Insurance  Premiums, 
not  deductible  as  expense,  312. 

LIMITED   LIABILITY   ASSOCIATIONS,    126. 

LIMITED    PARTNERSHIPS, 
see  also  Partnerships, 
foreign,  118. 
non-resident  alien,  jiartners  of,  118. 

LIQUIDATION    OF   CORPORATIONS,    130. 


634  INDEX 

LIST    RETUENS,   479. 

LIVE   STOCK, 
cost  of,  243. 
depreciation  of,  348. 
loss  of,  340. 

LIVING    QUAETERS,  232. 

LOCAL    BENEFITS, 

taxes  assessed  against,  326. 

LOCAL   BENEFITS,   ASSESSMENTS   FOE, 
not  deductible,  303. 

LOCAL    GOVERNMENTS,    INCOME    OF,    203. 

LOCAL  MUTUAL  OR  CO-OPEEATIVE  COMPANIES,  201. 

LODGE    SYSTEM,   DEFINED,   196. 

LODGES,   EXEMPT  WHEN,   196. 

LOSS  BY  OBSOLESCENCE  OF  PATENTS,  294. 

LOSSES, 

bonds  issued  below  par,  337.- 

charged   off  on   books,  when,  333. 

compensated  by   insurance,  333. 

cost  of  drilling,  dry  oil  or  gas  wells,  370. 

deduction  of,  331. 

due   to   adverse  judgment,  344. 

exchange  of  stock,  on,  335. 

fluctuations  in  market  prices,  333. 

foreign  corporations,  deductible  by,  186. 

income   of,   not   deductible  unless,   334. 

measure  of,  331. 

must  be  actually  sustained,  332. 

of  another,  paid  by  taxpayer,  336. 

voluntary  payment  of,  337. 
partnership,  partners   may   deduct,   when,   115. 
probable  losses,  333. 
property,  destruction  of,  339. 
reserves  for,  300,  333. 
retirement  of  bonds,  338. 
shrinkage  and  deterioration,  341. 
unpaid   instalments,   344. 
worthless  debts,  342. 
worthless  stock,  341. 


INDEX  635 


LOSSES  INCURRED  IN  TRADE, 

citizens  and  residents,  deduction  of,  32. 
non-resident  aliens,  deductible  by,  53. 
trust  estates,  deductible  by,  82. 

LOSSES  NOT  INCURRED  IN  TRADE, 

citizens  and  residents,  deduction  by,  33. 
non-resident  aliens,  deduction   by,  53. 
trust  estates,  deduction  by,  82. 

LOSSES  OF  PROPERTY, 

citizens  and  residents/  33. 
deduction  of,  331. 
non-resident  aliens,  53. 
voluntary  destruction,  by,  302. 

MAILING    RETURNS,  386. 

MAINTENANCE,  EXPENSES  OF,  308. 

MANAGEMENT  EXPENSES,  306. 

MANDAMUS,  400. 

MANNER  OF  PAYMENT  OP  TAX,  405. 

MANUFACTURED    PRODUCTS,    COST   OF,    305. 

MANUFACTURING    COMPANIES, 
gross  income  of,  236. 

MARCH"!, 

corporations,  when  return  filed  on,  9. 
individuals,  return  of  net  income  filed  on,  9. 
fiduciaries,  return  of  nipt  income  filed  on,  92. 

MARCH  1,  1913, 

depreciation  not  based  on  value  as  of,  351. 
dividends  from  earnings  accrued  prior  to,  269. 
gas  deposits,  fair  market  value  on,  363. 
interest   accruing  prior  to.  260. 
mining  deposits,  fair  market  value  on,  376. 
oil  deposits,  fair  market  value  on,  363. 
value  of  property  on,  250. 
value  ot  timberlands,  291. 

MARINE   INSURANCE   COMPANIES,   173. 

^rARRTED    PERSONS, 

jM^rsnnal  exemption  of,  37 


636  INDEX 

MARRIED    WOMAN, 

see  Husband  and  Wife. 

MASSACHUSETTS   REAL   ESTATE   TRUSTS,   126. 

MATERIALS  ON  HAND,  COST  OF  NOT  DEDUCTIBLE,  306. 

MEMBER    BANKS, 

dividends  from  Federal  Reserve  banks  exempt,  204. 

MERCANTILE    COMPANIES, 
gross  income  of,  236. 

MERCHANDISE, 

depreciation  on,  348. 

MERGERS, 

returns  of,  130. 

MILEAGE,  233. 

MIMEOGRAPH  LETTERS  TO   COLLECTORS,  5.  " 

MINES, 

royalties  from,  278. 

MINORS, 

becoming  of  age,  94. 
children  of  naturalized  citizens,  42. 
exemption  for,  37. 
entitled  to  personal  exemption,  37. 
claimed  by  guardian,  when,  90. 
having  separate  legal  estates,  25. 
income  from  trust  estates,  84. 
income  included  in  return  of  father,  when,  25. 
returns  filed  for,  94. 
returns  made  by  guardians,  25. 

MONEY    VALUE,  211. 
of  stock,  212. 
of  stock  dividends,  277. 

MONTHLY  LIST  RETURNS,  479. 

MUNICIPALITIES, 

interest  on  obligations  of,  257. 
mortgage  assumed  by,  258. 

MUTUAL    CASUALTY    INSURANCE    COMPANIES,    172. 

MUTUAL  EMPLOYERS'  LIABILITY  COMPANIES,   172. 


INDEX  637 

MUTUAL   FIRE   INSURANCE   COMPANIES,   170. 
capital   employed  in   business,  170, 
commissions  on  re-insurance,  171. 
deductions,  172. 
indebtedness,  170. 
interest,  171. 
ledger  assets,  maturity  of,  171. 

loss  on  sale  or  maturity  of,  171. 
loss  on  ledger  assets,  171. 
premiums,  net  amount  only  reported,  170. 
profits  on   sale  of  ledger  assets,  171. 
rentals,  net  only  reported,  171. 

MUTUAL  INSURANCE  COMPANIES,  EXEMPT  WHEN,  201. 

MUTUAL    LIFE    INSURANCE    COMPANIES,   173. 

MUTUAL    MARINE    INSURANCE    COMPANIES,    173. 

MUTUAL    PROTECTIVE    ASSOCIATIONS,    NOT    EXEMPT 
WHEN,  197. 

MUTUAL  SAVINGS  BANKS,  EXEMPT  WHEN,  196. 

MUTUAL  WORKMEN'S  COMPENSATION  COMPANIES,  172. 

NAME,  CHANGE.  OF  CORPORATE,  130. 

NATIONAL    BONDS    AND    OBLIGATIONS, 

partnership  profits,  deducted   from,  when,   112. 

NATIONAL  FARM-LOAN  ASSOCIATIONS  EXEMPT,  202. 

NAVY,  RETURNS   SIGNED  BY  PERSONS  IN,  389. 

NEGLECT  TO  FILE  RETURNS,  424. 

NET  ADDITION  TO  RESERVE  FUNDS,  167. 

NET   INCOME, 
see  Income. 

NINETEEN  HUNDRED  AND  NINE  LAW, 
defined,  2. 

depletion  of  nnines,  380. 
depletion  of  oil  or  gas  wells,  371. 
depreciation  writing  off  not  required,  357. 
limited   partnerships   taxed   under,   104. 
not   an   income   tax  law,  2. 


638  INDEX 

NINETEEN  HUNDRED  AND  NINE  LAW— Cont. 
rule  as  to  sale  of  property,  250. 
rulings  under,  3. 

NINETEEN  HUNDRED  AND  THIRTEEN  LAW, 
defined,    2. 

depletion  of  mines,  379. 
depletion  of  oil  or  gas  wells,  371. 
depreciation,  writing  off  not  required,  357. 
dividend  from  profits  earned  prior  to  March  1,  1913,  269. 
gifts,  rule  as  to,  283. 
on  corporations,  excise  tax,  when,  125. 
rules  as  to  sale  of  property,  250. 

special  rule  under,  251. 
rulings  under,  2. 
stock  diivdends,  rule  as  to,  274. 

NINETEEN  HUNDRED  AND  SIXTEEN  LAW, 
defined,  1. 

NINETEEN  HUNDRED  AND   SEVENTEEN  LAW, 
contains  no  administrative  provisions,  1. 
corporations  dissolved  before  passage  of,  131. 
defined,  1. 

NOMINAL    STOCKHOLDERS, 
definition  of  term,  66. 
duties  of,  when  actual  owner  is 

citizen  or  resident,  67. 

non-resident,  68. 
foi-eign  partnerships,  as,  121. 
partnerships  as,  121. 

NON-PAR  VALUE  SHARES,  142. 

NON-RESIDENT   ALIEN   CORPORATIONS,   181. 

NON-RESIDENT   ALIEN   PARTNERSHIPS,  117. 
see   Partnerships. 

NON-RESIDENT  ALIENS, 

abatement  of  taxes  assessed,  58. 
agents  of  may  file  returns,  57. 
annual  return,  55. 
bad  debts,  deduction  of,  54. 
beneficiary  of  trust  estate,  84. 
business   branches,   income   from,  44. 
deductions  in   computing  net  income,  51. 
depletion,  deduction  of,  54. 
depreciation,   deduction   of,  54. 
dividends,  how  reported,  54. 


INDEX  G39 

NON-RESIDENT  ALIENS— Cont. 
dividends,  income  from,  44. 

must  be  reported  in  annual  return,  45. 

not  subject  to  normal  tax,  when,  44. 

of  foreign  corporations,  not  taxed,  45. 

subject  to  supertax,  45. 
dividends  received  by,  266. 
excess  profits  tax  on,  503. 
expenses  which  are  deductible,  51. 
extent  to  which  taxable,  43. 
fiduciaries,  income  received  from,  48. 
income  from  miscellaneous  sources,  50. 
income  from  partnerships,  107. 
income  subject  to  tax,  when,  41. 
intending  to  become  residents,  42. 
interest,  income  from,  4^. 
interest  on  bank  deposits,  47. 
interest  paid,  deduction  of,  52. 
jurisdiction  over  income  of,  20. 
losses  incurred  in  trade,  53. 

not  incurred  in  trade,  53. 
nominal  stockholders,  69. 
partners  of  domestic  partnership,  107. 
partnerships,  income  from,  49. 
personal  exemption,  not  entitled  to,  10,  55. 
refund  of  taxes  paid,  58. 
residence,  how  determined,  41. 
return  of  annual  net  income,  55. 
returns  filed  by  fiduciaries,  for,  94.. 
salaries  paid  by  residents  to,  48. 
sale  of  property,  profits  on,  50. 
sources  within  the  United  States,  43. 
supertaxes  on,  11. 
taxes,  deduction  of,  53. 
temporarily   in   the   United   States,   42. 
tax  of,  how  and  when  paid,  57. 

how  abated  or  refunded,  57. 

how  released  by  withholding  agent,  56. 
tax  withheld  at  source,  how  reported,  54. 

release  of  amounts  withheld,  56. 
taxable  on  all  income  from  U.  8.,  21. 
taxable  status  of,  41. 
withholding,  tax  on  payments  to,  463. 

NON-RESIDENT    CITIZENS,  23. 
acting  as  fiduciaries,  73. 

NON-RESIDENT  FOREIGN  PARTNERSHIP,  119. 

NON  RESIDENTS,  DEFINITION  OF  TERM,  fiO. 


640  INDEX 

NORMAL    TAX, 

applies  to  all  net  income  over  exemption,  16. 
personal  exemption  from  each  tax,  16. 
rate  under  1916  Law,  15. 

applies  to  all  individuals,  15. 
rate  under  1917  Law,  15. 

does  not  apply  to  non-resident  aliens,  16. 
rates  of,  11. 

NOTARY  PUBLIC,  SEAL  OF  NECESSARY,  WHEN,  389. 

NOTES, 

of  corporations,  461. 
tax  withheld  on,  460. 

NOTES,  INCOME  IN  FORM  OF„221. 

NOTICE    AND    DEMAND    FOR    TAX,    401. 

NOTICE  OF, 

additional  assessment,  391. 
assessment,  401. 
failure  to  file  returns,  392. 
lien,  417. 

tax,  and  demand  for,  401. 
second  notice,  403. 

OBSOLESCENCE, 

no  allowance  for  anticipated,  349. 
patents  of,  294. 

OFFERS  IN  COMPROMISE  OF'  PENALTIES,  429. 

OFFICE  FURNITURE,  COST  OF,  309. 

OIL  WELLS,  362. 

OIL  WELLS,  DEPLETION  OF, 

citizens  and  residents,  deduction  by,  35. 

OPERATION,  EXPENSE  OF,  305. 

ORDINARY   AND   NECESSARY   EXPENSES,    135. 

ORGANIZATION  EXPENSES,  136. 

OVERHEAD  CHARGES,  211. 

OVERPAYMENT  OF  TAX, 

discovered  after  two  years,  442. 
refund  of,  441. 


INDEX  641 

OWNERSHIP  CERTIFICATES,  471. 
disposition  of,  480. 

PANAMA   CANAL   ZONE,  • 

status  of  citizens  and  residents,  8. 

PARENT    COMPANIES, 

file  list  of  subsidiaries,  158. 
returns  by,  158. 

PARTITION,  RECEIVER  IN  PROCEEDINGS  FOR,  89. 

PARTNERS, 

see  partnerships.  ' 

partnership  profits  not  subject  to  withholding,  460. 

returns  by,  of  foreign  partnership,  124. 

PARTNERSHIP    ASSOCIATIONS,  105 

PARTNERSHIPS, 

annual  return  not  filed  by,  9. 
deductions  allowed  to,  109. 
definition  of,  103. 
deriving  income  from  abroad,  49. 
dividends  received  by,  113. 
domestic  partnerships.  103. 
excess  profits  tax  on,  503. 
fiscal  year  may  fix,  113. 

rate  of  tax,  when  changed,  113. 
general  not  separate  entity,  108. 

not  taxed,  103. 
income  from,  non-resident  aliens,  49. 
income  from  sources  abroad,  107. 
insurance  premiums,   104. 

deductions  allowed  to,  109. 

normal  tax  on  profits,  when,  105. 

operating  abroad,  107. 

profits  of,  as  dividends,  104. 

taxable  as  corporations,  103. 

taxable  under  1909  Law,  104. 
losses,  net,  partners  may  deduct,  115. 
net  income  of,  108. 

non-resident  alien  partners  of,  49,  107. 
not  taxable  as  such,  103. 
operating  abroad,  107. 
partners  of,  operating  abroad,  107. 
paying  out  income,  duties  of,  108. 
private  banks,  taxed  as  corporations,  when,  106. 
procedure  in  collecting  income,  108. 
F.  I.  Tax.— 41 


642  INDEX 

PAETNERSHIPS— Cont. 

profit  sharing  payments,  109. 

profits  earned  prior  to  March  1,  1917,  114. 

profits  of,  reported  by  partners,  110. 

accounts  receivable,  as,  111. 

amount  shown  by  book,  111. 

normal  and  supertax  imposed  on, 

tax  withheld  at  source,  110. 
returns  by,  115. 

special  returns,  116. 
salaries  of  partners,  231. 

withholding  on,  when,  460. 

PATENTS, 
cost  of,  294. 

deduction  for  loss  of  capital,  294. 
royalties  from,  294. 

PAYMENT    OF    TAX, 
advance,   404. 
by  check,  406. 
manner  of,  405, 
time  of,  404. 

PAYMENTS  BY  TENANT  FOR  LANDLORD,  253. 

PAYMENTS  OF  INCOME  TO  OTHERS,  DUTIES  IN,  450. 

PENALTIES, 

advance  payments  made  under,  405. 
compromise  of,  427. 
delay  in  payment  of  tax,  425. 
failure  to  file  returns,  421. 

exception,  422. 
failure  to  withhold  tax,  425. 
false  returns,  424. 
fines,  425. 

fraudulent  returns,  424. 
information  at  source,  425. 
injunction  against  collection  of,  421. 
intentional  neglect,  424. 
protest,  payment  under,  408. 
specific  penalty,  421. 
not  waived,  424. 
statute  of  limitations,  427. 
withholding  agents,  423. 

PENSIONS, 

deductible,  when,  317. 
income  from,  282. 


INDEX  643 

PER  DIEM  ALLOWANCES,  233. 

PERSONAL  EXEMPTION, 
amount  of,  37. 
children,  allowance  for,  10. 
citizens  and  residents  only  entitled  to,  10,  37. 
claimed  according  to  status  at  end  of  year,  39. 
•     head  of  family  entitled  to,  10. 

non-resident  aliens,  not  entitled  to,  55. 
normal  tax,  applies  toy  10. 
persons  dying  during  year,  39. 
separate,  under  each  law,  10. 
supertax,  does  not  apply  to,  40. 

PERSONAL  LIVING  OR  FAMILY  EXPENSES,  30. 

PERSONAL  SERVICES,  INCOME  FROM,  229. 
see  Compensation. 

PERSONS  DYING  DURING  THE  YEAR,  27, 

PERSONS  EXEMPT  FROM  TAX,  21. 

PHILIPPINE  ISLANDS, 

administration  of  law  in,  7. 
corporations  operating  in,  129. 
income  accruing  to,  203. 
income  from,  225. 
legislature  may  amend  law,  8. 
1917  Law  does  not  extend  to,  8. 
officers  and  employees  of,  234. 
taxpayers  doing  business  in,  8. 

PIPE  LINES,  DEPRECIATION  ON,  354. 

PLANTATIONS,  242. 

POLICIES,  PAYMENTS  ON,  169. 

POLITICAL  AND  TAXING  SUBDIVISIONS  OF  STATES,  113. 
agencies  not  governmental,  257. 
defined,  258. 
employees  of,  21. 

PORTO  RICO, 

administration  of  law  in,  7. 
corporations  operating  in,  129. 
income  accruing  to,  203. 
income  from,  225. 
legislature  may  amend  law,  8. 
1917  Law  does  not  extend  to,  8. 


644  INDEX 

POETO  EICO— Cont. 

oflS.cers  and  employees  of,  234. 
taxpayers  doing  business  in,  8. 

POSSESSIONS  OF  THE  UNITED  STATES, 
interest  on  obligations  of,  257. 

POTENTIAL  INCOME,  206. 

POWEB  OF  CONGRESS  TO  LEVY  TAX,  488. 

PEEMIUMS— LIFE  INSUEANCE,  312. 

PEESENT  FEDEEAL  INCOME  TAX  LAWS,  1. 

PEESIDENT  OF  THE  UNITED  STATES,  235.      ' 

PREWAE  PEEIOD,  508. 

PEINCIPAL,  INCOME  RECEIVED  BY  AGENT  FOR,  224. 

PRINCIPAL  OFFICE,  158. 

PRIVATE  BANKS, 

taxed  as  corporations,  when,  106. 

PRIVATE    RESIDENCE,    NO    DEPRECIATION    ALLOWED 
ON,  346. 

PROCEDURE  IN  CLAIMING  ABATEMENT,  439. 
in  claiming  refund,  442. 

PROCEDURE     IN     COLLECTING     INCOME     SUBJECT     TO 
WITHHOLDING,  471. 

PROCEEDS  OF  LIFE  INSURANCE  POLICIES,  282. 
in  favor  of  corporations,  283. 

PROFESSIONAL  FEES,  229. 
see  Compensation. 

PROFESSIONS,  INCOME  FROM,  235. 

PROFIT  FROM  SALE  OF  PROPERTY,  245. 

PROFIT  SHARING, 

fixed  and  determinable  income,  when,  459. 
income  to  recipient,  230. 
partnership,  payment  by,  109. 

PROPERTY  ACQUIRED  BY  CORPORATION  FOR  STOCK,  247. 


INDEX  645 

PROPERTY  LEFT  BY  DECEDENT,  SALE  OP, 
appraised  value  of,  taken  as  cost,  249. 

PROPERTY  RENEWED  CONTINUOUSLY,  354. 

PROPERTY  SUBJECT  TO  WEAR  AND  TEAR,  346. 

PROPERTY,  VALUE  OF  ON  MARCH  1,  1913,  250. 

PROTEST, 

form  of,  408. 

necessary  in  suits  to  recover  taxes,  407. 

not  necessary  for  refund,  407. 

not  sufficient  unless  duress,  409. 

penalties  included  in,  408. 

returns  filed  under,  407. 

tax  paid  under,  407. 

PUBLIC  UTILITIES, 

income  from,  exempt  when,  240. 

income  of,  301. 

income  of  accruing  to  states,  territories,  etc.,  203. 

permanent  improvements,  301. 

service  connections,  302. 

under  contract  with  a  state,  319. 

PURCHASE  OF  BONDS  WITH  ACCRUED  INTEREST,  259. 

QUASI-CORPORATIONS,  104. 

RANCHES,  242. 

RATE  OF  DEPRECIATION  ALLOWANCE,  355. 

RATE  OF  TAX, 
dividends,  264. 

from  surplus  earned  in  prior  years,  267. 
domestic  corporations, 
foreign  corporations, 
individuals, 
non-resident  aliens, 
trust  estates, 
withheld  on  dividends,  464. 

on  bond  interest,  465. 
withheld  on  payments  to, 

agents,  470. 

citizens  and  residents,  468. 

corporations,  469. 

fiduciaries,  469. 

nominal   stockholders,  470. 

non-resident  aliens,  468. 

partnerships,  469. 


646  INDEX 

BATES  OF  EXCHANGE, 

income  computed  on,  when,  224. 

EEAL  ESTATE, 

depreciation  on,  347. 
when  collateral,  144. 

REAL  ESTATE  AGENTS, 
commissions  paid  to,  306. 

REAL  ESTATE  TRUSTS,  126. 

REASONABLE  ALLOWANCE  FOR  DEPRECIATION,  355. 

RECEIPT  FOR  TAX,  412. 

RECEIPT  OF  CASH,  INCOME  WHEN,  206, 

RECEIPT  OF  INCOME  BY  AGENT,  224. 

RECEIPTS  REPRESENTING  RETURN  OF  CAPITAL,  222. 

RECEIPTS  WHICH  ARE  RETURN  OF  CAPITAL,  286. 

RECEIVERS, 

corporations,  for,  duties,  152. 
of  individuaJs,  75. 
duties  of,  78. 
IJartition  proceedings,  89. 

RECOVERIES  OF  BAD  DEBTS,  284. 

RECOVERY  OF  TAX,  WHO  MAY  CLAIM,  437. 

RECOVERY  OF  TAXES,  443. 
interest,  447. 

RECOVERY  OF  TAXES  BY  ACTION  AT  LAW, 

protest,  necessary  to  jjay  tax  under,  408. 

REFUND  OF  TAXES  COLLECTED,  440. 
interest  not  allowed,  447. 
procedure  in  claiming,  442. 
stattite  of  limitations,  441. 
extended  when,  442. 

REFUND  OF  TAXES  PAID, 
general  statement,  14. 

REFUSAL  TO  FILE  RETURNS,  424. 


INDEX  647 

REGISTERED  INTEREST,  PAYMENT  OF,  478. 

REGULATIONS,  5. 

REIMBURSEMENT  FOR  ACTUAL  EXPENSES,  233. 

REJECTION  OF  CLAIM  FOR  ABATEMENT,  438. 

RELEASED  RESERVES,  169. 

RELIGIOUS  ORGANIZATIONS,  EXEMPT  WHEN,  199. 

REMEDY  AGAINST  ERRONEOUS  ASSESSMENT,  400. 

REMOVAL  OF  BUILDINGS  INCIDENT  TO  IMPROVEMENT, 
302. 

RENEWALS  TO  PROPERTY,  354. 

RENT, 

equivalent  of  cash,  received  in,  221. 
fixed  and  determinable  income,  when,  459. 
income  from,  252. 
[taid  in  kind,  211. 
payments  in  lieu  of,  136. 
received  in  kind,  254. 

RENTAL  VALUE  OF  BUILDINGS,  347. 

REORGANIZATION  OF  CORPORATIONS, 
income  from,  216. 
loss  on,  334. 
surplus,  taxability  of,  220. 

REPAIRS,  COST  OF,  308. 
incidental,  defined,  309. 

REPORTING  INCOME  ON  BASIS  OF  BOOK  ENTRIES,  227. 
same  basis  must  be  used  consistently,  228. 
system  of  accounting  must  clearly  reflect  income,  227. 

REPORTING  NET  INCOME,  9. 

RESERVE  FUND, 

*  must  be  required  by  law,  168. 
net  addition  to,  167. 
released  reserves,  169. 

RESERVES  FOR, 
depreciation,  357. 
dividends  from,  271. 


648  INDEX 

KESERVES  FOR— Cont. 
losses,  333. 
self  insurance,  not  deductible,  313. 

RESERVES  TO  MEET  LIABILITIES,  .    ' 

contingent  losses,  300. 
deductible  when,  300.  ^ 

RESIDENCE,  DEFINITION  OF,  24. 
of  domestic  corporations,  46,  128. 
English  rule,  46. 

RESIDENT  AGENTS  FOR  FOREIGN  CORPORATIONS,  182. 

RESIDENT  AGENTS  FOR  NON-RESIDENTS, 
definition  of,  59. 
duties  and  liabilities  of,  62. 
who  are  held  to  be,  59. 
who  are  not  such  agents,  61. 

RESIDENT  ALIEN  CORPORATIONS,  180. 

RESIDENT  FOREIGN  PARTNERSHIPS,  119. 

RESIDENTS,  MAY  BE  REQUIRED  TO  REPORT  AS  AGENTS 
FOR  NON-RESIDENT  ALIENS  AND  FOREIGN  CORPORA- 
TIONS, 59. 

RESTORING  PROPERTY, 

expense  of,  not  deductible,  when,  302.     • 

no  depreciation  when,  354,  ] 

RETROACTIVE  EFFECT  OF  TAX, 
constitutionality  of,  493. 
corporations  dissolved  during  year,  131. 
individuals  dying  during  year,  27. 

RETROACTIVE  RULINGS,  5. 

RETURN  OF  ANNUAL  NET  INCOME, 
agents,  by,  384. 
amended,  391. 
assistance  of  collectors,  390. 

by  whom  filed,  382.  0 

corporations,  requirements  as  to,  157. 
erroneous,  391. 
extension  of  time,  j 

applications  for,  387. 

by  collectors,  386.  ' 

by  commissioner,  387. 
fiduciaries,  when  required  of,  91. 


INDEX  649 

RETURN  OF  ANNUAL  NET  INCOME— Cont. 
final  return  of  corporations,  130. 
foreign  corporations  by,  189. 
foreign  fiduciaries,  by,  100. 
forms,  388. 

husband  and  wife,  383. 
incompetent  beneficiary  of  trust  estate,  84. 
inspection  of,  392, 
joint  fiduciaries,  by  whom  filed,  90. 
last  due  date,  386. 
made  by  collector,  390. 
mailing  returns,  386. 
minor  beneficiary  of  trust  estate,  84. 
notice  of  failure  to  file,  392. 
only  one  return  required,  1. 
partners  of  foreign  partnerships,  124. 
partnerships  not  required  to  file,  115. 
penalty  for  failure  to  file,  421. 

exception,  422. 
residents  required  to  file  for  non-residents,  when,  62. 

procedure,  63. 
statement  of  depletion  of  mines,  379. 
statement  of  depletion  of  oil  and  gas  wells,  370. 
supplementary  statement,  160. 

tentative  returns,  387.  • 

verification  of,  389. 

abroad,  389. 

in  army  and  navy,  389. 
voluntarily  filed  after  due  date,  422. 
when  filed,  385. 
where  filed,  384. 

REVENUE  AGENTS,  4. 

may  examine  taxpayer's  books,  433. 
may  take  afiSdavit  to  returns,  389. 

RIGHTS  TO  SUBSCRIBE  TO  STOCK,  285. 

ROYALTIES, 

from  copyrights,  295. 

from  patents,  294. 

income  from,  278, 

paid  by  lessees  of  oil  or  gas  property,  367, 

tax  not  withheld  on,  when,  461, 

RULINGS  AND  REGULATIONS, 

issued  for  guidance  of  taxpayers,  5. 
ofScial  publication  of,  5. 
retroactive  effect  of,  5, 


650  INDEX 

SALABIES,  229. 

see  Compensation. 

based  on  stockholding,  315. 

deductible  as  business  expense,  when,  313. 

dividend,  held  to  be,  when,  230. 

equivalent  of  cash,  received  in,  221. 

not  paid  in  cash,  212. 

paid  by  residents  to  non-resident  aliens,  48. 

partners,  of,  231. 

soldiers,  paid  to,  by  ex-employers,  315. 

stockholders  of  corporations,  314. 

taxable  in  year  received,  223. 

SALE  OF, 

bonds  with  accrued  interest,  259. 
capital  stock  by  corporation,  135. 
farm  products,  243. 
stock  dividends,  277. 

SALES  AND  DEALINGS  IN  PROPERTY,  245. 

SALES,  LOSSES  ON,  335. 

SALES  ON  APPROVAL,  239. 

SALVAGE  VALUE  OF  DESTROYED  PROPERTY,  340. 

SAVINGS  BANKS,  EXEMPT  WHEN,  196. 

SCHOOL  DISTRICTS,  INTEREST  PAID  BY,  258. 

SCHOOL  TEACHERS,  PUBLIC,  EXEMPTION  OF,  22. 

SCIENTIFIC  ORGANIZATIONS,  EXEMPT  WHEN,  199. 

SCRIP  DIVIDENDS,  272. 

SECOND  ASSESSMENT,  412. 

SECOND  NOTICE  AND  DEMAND  FOR  TAX,  403. 

SECRETARY  OF  TREASURY, 

fraudulent  accumulation  of  profits,  action  of,  19. 

SECURITIES  DISTRIBUTED  AS  DIVIDENDS,  272. 

SECURITIES,  VALUE  OF  ON  MARCH  1,  1913,  250. 

SELLING  PRICE  OF  PROPERTY,  251. 

SERVICES  EXTENDING  OVER  A  YEAR,  PAYMENT  FOR, 
232. 


INDEX  651 

SHARES  WITHOUT  PAR  VALUE,  142. 

SHRINKAGE, 

of  produce  in  storage,  243. 
of  property  in  storage,  341. 

SHRINKAGE  IN  VALUES, 

reserves  for,  not  deductible,  300. 

SINKING  FUNDS, 

amounts  credited  to,  300. 
income  from,  281. 

SOCIETIES  (FRATERNAL)  EXEMPT  WHEN,  196. 

SOURCES  WITHIN  THE  UNITED  STATES, 
non-resident  aliens,  income  from,  43. 

SPECIAL  RETURNS, 

foreign  partnerships,  123. 

SPECIFIC  EXEMPTION, 

to  trust  estates,  on  undistributed  income,.  89. 

SPECIFIC  PENALTY,  421. 
compromise  of,  428. 
not  waived  by  accepting  returns,  424. 

STATE  EMPLOYEES, 
exemption  of,  21. 

STATE  OFFICERS  MAY  INSPECT  RETURNS,  WHEN,  398. 

STATES  AND  POLITICAL  SUBDIVISIONS  OF, 

income  accruing  to,  203.  , 

interest  on  obligations  of,  112,  255. 
officers  and  employees  of,  234. 
partnership  profits,  deducted  fronj,  112. 

STATUTES  OF  LIMITATIONS, 

none  on  collection  of  tax  by  suit,  416. 
penalties,  in  case  of,  427. 
refund,  as  to,  441. 

extended  when,  442. 
suits  to  recover  taxes,  as  to,  444. 
summary  assessment,  414. 

STATUTORY  OFFICE,  158. 

STEAMSHIP   COMPANIES,   FOREIGN.    179. 
agents  may  file  returns,  191. 
income  of,  183. 


652  INDEX 

STOCK, 

depreciation  not  allowed,  349. 
worthless,  341. 

STOCK,  ASSESSMENTS  ON,  281. 

STOCK  BOUGHT  AT  DIFFERENT  PRICES,  SALE  OF,  247. 

STOCK  DIVIDENDS,  274. 
amount  to  be  reported,  277. 
money  value  of,  277. 
sale  of,  profit  on,  277. 

STOCK  HELD  BY  NOMINAL  OWNERS,  66. 

STOCK  IN  EXCHANGE  FOR  SERVICES,  214. 
in  exchange  for  property,  215. 
in  exchange  for  stock,  217. 

STOCK  ISSUED  FOR  PATENTS,  294. 

STOCK  ISSUED  FOR  PROPERTY,  247. 

STOCK  OUTSTANDING,  159. 

STOCKHOLDERS, 

lessor  corporations,  income  of,  151. 

salaries  paid  to,  230. 

suit  to  restrain  officers  from  paying  tax,  309. 

taxed  on  fraudulent  accumulation  of  corporation,  18. 

taxes  paid  for,  by  corporation,  327. 

voluntary  payment  of  loss  of  corporation,  337, 

worthless  stock,  341. 

STOCKHOLDERS  OF  RECORD,  66. 

STOPPAGE  AT  THE  SOURCE,  12. 

STUMP  AGE,  ALLOWANCE  FOR,  290. 

SUBSIDIARY  COMPANIES,  146. 

SUBSIDIARY  CORPORATIONS, 

returns  by,  158. 
separate  returns  of,  158. 

SUBSTITUTE  CERTIFICATES,  473. 

SUIT  FOR  COLLECTION  OF  TAX,  416. 


INDEX  653 

SUITS  TO  RECOVER  TAXES,  443. 
against  collectorSj  445. 
against  the  U.  S.,  446. 
costs,  recovery  of,  449. 
interest,  recovery  of,  447. 
when  brought,  444. 

SUMMARY  ASSESSMENT,  412. 

SUPERTAX, 

applies  to  all  individuals,  11. 
corporations,   not  imposed   on,   15. 
corporations,  not  subject  to,  125. 
husband  and  wife,  on  income  of,  18. 
Liberty  bonds,  second  issue,  256. 
on  undistributed  profits  ©^corporations,  18. 
rates  of,  16. 

illustration,  17. 
tax  on  undistributed  profits  called, 
tax  under  both  laws  imposed,  11. 

"SUPERTAX"  ON  CORPORATIONS,  495. 

SUPPLEMENTARY  STATEMENT  OF  CORPORATIONS,  160. 
may  be  varied,  161. 

SURPLUS, 

taxability  of,  on  reorganization,  220. 

SURRENDER  VALUE  OF  INSURANCE  POLICIES,  288. 

SURTAX,  DEFINITION  OP,  15. 

SYNDICATES,  126. 

T.  D., 

defined,  5. 

TAX, 

on  income  or  on  person,  20. 

paid  by  residents  for  non-residents,  when,  64. 

TAX  pUE,  14. 

TAX-EXEMPT  COVENANTS,  482. 

TAX-FREE  BONDS, 
interest  paid  on,  145. 

TAX-FREE  COVENANTS,  482. 


654  INDEX 

TAX   ON   UNDISTRIBUTED   NET    INCOME    OF    CORPORA- 
TIONS, 

corporations  subject  to  this  tax,  496. 

income  taxes  paid  within  year,  498. 

net  income  invested  in  business,  499. 

invested  in  obligations  of  the  U.  S.,  501, 
retained  for  employment  in  business,  499. 

penalty  tax,  502. 

rate  of  tax,  501. 

increased  when,  502. 

returns,  502. 

undistributed  net  income,  496. 

TAXES, 

added  to  cost  of  property,  when,  246. 
assessed  against  local  benefits,  326. 
bondholders,  paid  for,  326. 
citizens  and  residents,  deduction  of,  31. 
corporations,  deductible  by,  140. 
deductible  when,  324. 
excess  profits  taxes,  federal,  325. 
foreign  corporations,  deductible  by,  189. 
income  taxes,  federal,  325. 
inheritance,  not  deductible,  322. 
non-resident  aliens,  deductible  by,  53. 
not  deductible  when,  325. 
paid  for  stockholders,  273. 
paid  within  year,  324. 
stockholders,  paid  for,  327. 
.  tenant  paid  by,  330. 
trust  estates,  deductible  by,  81. 

TAX  WITHHELD  AT  SOURCE  BY  WHOM,  476. 

TAXPAYER, 

law  construed  in  favor  of,  6. 

TELEPHONE      COMPANIES,      CO-OPERATIVE,      EXEMPT 
WHEN,  201. 

TENANT, 

buildings  erected  by,  cost  of,  311. 
depreciation   on  building  erected  by,  358. 
improvements  made  by,  value  of,   252. 
incidental  repairs,  may  deduct,  312. 
insurance  premiums  deductible  when,  312. 
lessor   and   lessee   corporations,   149. 
payment  in  lieu  of  rent,  311. 
payments  by,  for  landlord,  253. 
rent  paid  in  one  sum,  311. 


INDEX  655 

TENANT— Cont. 

repairs  and  improvements,  cost  of,  311. 
taxes  paid  for  landlord,  330. 

TENTATIVE  RETURNS,  387. 

TERRITORIES  AND  POLITICAL  SUBDIVISIONS  OF, 
income  of,  203. 

interest  on  obligations  of,  257. 
oflScers  and  employees  of,  234. 

THEFT  OF  PROPERTY,  339. 

THREE-YEAR  LIMITATION  ON  SUMMARY  ASSESSMENT, 
414. 

TIMBERLANDS,  INCOME  FROM,  290. 

TIME  WHEN  LIEN  ATTACHES,  418. 

TRADE,  INCOME  FROM,  236. 

TRAVELING  SALESMEN  OF  FOREIGNERS,  177. 

TREASURY  DECISIONS,  5. 

TREASURY  DEPARTMENT, 

effect  of  construction  of  law  by,  7. 
pays  no  interest,  447. 

TREASURY  STOCK,  NOT  STOCK  OUTSTANDING,  160. 

TRUST  AGREEMENTS,  126. 

TRUST  ESTATES, 

deductions  allowed  to,  80. 
definition  of  term,  79. 
distribution  of  income  of,  84. 
dividends  received  by,  271. 
foreign  fiduciaries,  98. 
income  of,  79. 
foreign,  99. 

TRUSTEE,  PAYMENT  TO,  FOR  SERVICES  DURING  PERIOD 
OF  TRUST,  232. 

TRUSTEES, 

are  fiduciaries,  75. 
foreigners  acting  as,  98. 
non-resident  aliens  acting  as,  98. 
personal   exemption   for  beneficiary,  37. 


656 


INDEX 


TEUSTEES— Cont. 
net  •income  of,  83. 
specific  exemption  allowed  to,  38. 
specific  exemption  on  undistributed  income,  89.  . 

TRUSTS  TAXABLE  AS  CORPORATIONS,  WHEN,  127. 

TUCKER  ACT,  446. 

UNCERTIFIED  CHECKS  IN  PAYMENT  OP  TAX,  405. 

UNDISTRIBUTED  INCOME  OP  CORPORATIONS,  TAX  ON, 

495.  '  ' 

UNDISTRIBUTED  INCOME   OP  TRUST  ESTATES,  87. 
estates  administered  in  foreign  countries,  99. 
set  aside  for  or  credited  to  beneficiaries,  88. 

UNDIVIDED   PROFITS  AND  SURPLUS, 
most  recently  accumulated,  268. 

UNEARNED   INCREMENT,  350. 

UNIFORMITY  OF  TAX,  493. 

UNITED    STATES, 

certificates  of  indebtedness  in  payment  of  tax,  405. 
interest  on  obligations  of,  255. 
officers  of  may  inspect  returns,  when,  398. 
suits  against,  to  recover  taxes,  446. 

UNMARRIED   PERSONS, 
personal  exemption,  37. 

may  be  head  of  family,  38. 

UNPAID    ACCOUNTS,  207. 

VERIFICATION   OF   RETURNS,   389. 

VIRGIN    ISLANDS, 

status  of  citizens  and  residents,  8. 

VOCATIONS,  229. 

income  from,  235. 

VOLUNTARY  DESTRUCTION  OF  PROPERTY,  SOS. 

VOLUNTARY   OFFERINGS  ARE   INCOME,  WHEN,   231. 

VOLUNTARY  PAYMENT  OF  TAX  UNDER  PROTEST,  409. 


INDEX  (>57 


WAGES,  229. 

see  Compensation. 


WAIVING  THREE- YEAR  LIMITATION,  41G. 

WAR  EXCESS  PROFITS  TAX, 

administrative   provisions,   533.  » 

annual  returns,  532. 
corporation,  505. 
deductions,  527. 

of  business  having  nominal  capital,  530. 

specific  exemption,  529. 
domestic  corporations, 

net  income  of,  509. 

for   prowar  period,  510. 
foreign  corporations, 

net  income  of,  511. 
general  statement,  504. 
individuals,  506. 

net  income  of,  512. 
invested  capital,  512. 

average  for  year,  513. 

borrowed  money  not  included,  513. 

business  carried  on  by  successor,  514. 

investment  in  bonds  not  included,  when.  513. 

investment  in  certain  assets  not  included,  513. 

investment  in  stocks  not  included,  513. 
invested  capital  of  corporations  and  partnerships,  515. 

actual  cash  paid  in,  515. 

franchise,  518. 

^ood-will,  517. 

intangible  property,  518. 

patents  and  copj-rights,  517. 

surplus  and  individual  ]irotits,  .'320. 

tangible  property  paid   in,  ;"1H. 

tradebrands,  518. 

trademarks,  517. 
•invested  capital  of  foroijja  coritoratioits,  52;». 
invested  capital  of  individuals,  523. 
investe^l  capital  of  non-resident  aliens,  526. 
nominal  capital,  526. 
occupations,  508. 
partnerships,  506. 

net  income  of,  511. 
prewar  period,  508. 
professions,  508. 
rate  of  tax,  530. 

in  case  of  nominal  capital,  532. 
tax  paid  under  former  law,  532. 
taxable  year,  507. 
P.  I.  Tax.— 42 


658 


IND£X 


WAR  EXCESS  PEOFITS  TAX— Cont. 
trade  and  business,  508. 
United  States,  507. 

WAR  INCOME  TAX,  1. 

WARD,  76.  ^ 

WEARING    APPAREL, 

depreciation  on,  when,  348. 

WIDOW, 

may  be  head  of  family,  38. 
of  alien,  42. 

WIDOWER, 

may  be  head  of  family,  38. 

WITHHOLDING    AGENTS, 
defined,  463. 
duties  of,  478. 

may  also  be  held  to  be  resident  agents,  59. 
penalty  for  failure  to  file  returns,  423. 

WITHHOLDING  AT  THE  SOURCE,  12. 

WORTHLESS    DEBTS, 

capital,  representing,  342. 

citizens  and  residents,  deduction  by,  34. 

how  determined,  343. 

income,  representing,  342. 

must  be  charged  off,  343. 

non-resident  aliens,  deductible  by,  54. 

recoveries  of,  284. 

reserves  for,  not  deductible,  300. 

two  class,  distinction,  342. 

WORTHLESS    STOCK,  341. 


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